If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, from a first glance at Deyun Holding (HKG:1440) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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. Analysts use this formula to calculate it for Deyun Holding:

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

0.073 = CN¥25m ÷ (CN¥380m - CN¥43m) (Based on the trailing twelve months to December 2021).

Therefore, Deyun Holding has an ROCE of 7.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 10%.

View our latest analysis for Deyun Holding

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

What The Trend Of ROCE Can Tell Us

In terms of Deyun Holding's historical ROCE movements, the trend isn't fantastic. Over the last four years, returns on capital have decreased to 7.3% from 17% four years ago. 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 related note, Deyun Holding has decreased its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

We're a bit apprehensive about Deyun Holding because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 50% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Deyun Holding does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.