Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating China Mengniu Dairy (HKG:2319), 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. To calculate this metric for China Mengniu Dairy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.06 = CN¥5.4b ÷ (CN¥123b - CN¥34b) (Based on the trailing twelve months to June 2023).
Thus, China Mengniu Dairy has an ROCE of 6.0%. Ultimately, that's a low return and it under-performs the Food industry average of 9.3%.
In the above chart we have measured China Mengniu Dairy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for China Mengniu Dairy .
The Trend Of ROCE
On the surface, the trend of ROCE at China Mengniu Dairy doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.0% from 7.9% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a related note, China Mengniu Dairy has decreased its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
What We Can Learn From China Mengniu Dairy's ROCE
In summary, China Mengniu Dairy is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 22% over the last five years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
If you want to continue researching China Mengniu Dairy, you might be interested to know about the 1 warning sign that our analysis has discovered.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.