Returns On Capital Signal Difficult Times Ahead For China Yuchai International (NYSE:CYD)
What financial metrics can indicate to us that a company is maturing or even in decline? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. So after glancing at the trends within China Yuchai International (NYSE:CYD), we weren't too hopeful.
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. Analysts use this formula to calculate it for China Yuchai International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = CN¥492m ÷ (CN¥24b - CN¥11b) (Based on the trailing twelve months to June 2023).
So, China Yuchai International has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.
Check out our latest analysis for China Yuchai International
Above you can see how the current ROCE for China Yuchai International compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
We are a bit worried about the trend of returns on capital at China Yuchai International. Unfortunately the returns on capital have diminished from the 11% that they were earning five years ago. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on China Yuchai International becoming one if things continue as they have.
On a separate but related note, it's important to know that China Yuchai International has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In Conclusion...
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 12% over the last five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
One more thing, we've spotted 1 warning sign facing China Yuchai International that you might find interesting.
While China Yuchai International 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.
