Yunnan Water Investment's (HKG:6839) Returns On Capital Not Reflecting Well On The Business

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Yunnan Water Investment (HKG:6839) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Yunnan Water Investment, this is the formula:

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

0.0059 = CN¥128m ÷ (CN¥49b - CN¥27b) (Based on the trailing twelve months to June 2022).

So, Yunnan Water Investment has an ROCE of 0.6%. Ultimately, that's a low return and it under-performs the Water Utilities industry average of 6.5%.

Check out 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 5.3% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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.

On a side note, Yunnan Water Investment's current liabilities have increased over the last five years to 56% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

What We Can Learn From Yunnan Water Investment's ROCE

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. Unsurprisingly then, the stock has dived 86% over the last five years, so investors are recognizing these changes and don't like the company's prospects. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Yunnan Water Investment (including 2 which can't be ignored) .

While Yunnan Water Investment isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.