Yunnan Water Investment (HKG:6839) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Yunnan Water Investment (HKG:6839), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Yunnan Water Investment is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.013 = CN¥453m ÷ (CN¥47b - CN¥12b) (Based on the trailing twelve months to June 2023).

Thus, Yunnan Water Investment has an ROCE of 1.3%. In absolute terms, that's a low return and it also under-performs the Water Utilities industry average of 6.0%.

View our latest analysis for Yunnan Water Investment

Historical performance is a great place to start when researching a stock so above you can see the gauge for Yunnan Water Investment's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of Yunnan Water Investment, check out these free graphs here.

So How Is Yunnan Water Investment's ROCE Trending?

In terms of Yunnan Water Investment's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 5.5% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Bottom Line

From the above analysis, we find it rather worrisome that returns on capital and sales for Yunnan Water Investment have fallen, meanwhile the business is employing more capital than it was five years ago. This could explain why the stock has sunk a total of 86% in the last five years. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 4 warning signs with Yunnan Water Investment (at least 3 which are significant) , and understanding them would certainly be useful.

While Yunnan Water Investment may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.