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YuanShengTai Dairy Farm Limited (HKG:1431) Might Not Be A Great Investment

Today we’ll look at YuanShengTai Dairy Farm Limited (HKG:1431) and reflect on its potential as an investment. Specifically, we’ll consider its Return On Capital Employed (ROCE), since that will give us an insight into how efficiently the business can generate profits from the capital it requires.

Firstly, we’ll go over how we calculate ROCE. Second, we’ll look at its ROCE compared to similar companies. And finally, we’ll look at how its current liabilities are impacting its ROCE.

Return On Capital Employed (ROCE): What is it?

ROCE measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. Generally speaking a higher ROCE is better. Ultimately, it is a useful but imperfect metric. Renowned investment researcher Michael Mauboussin has suggested that a high ROCE can indicate that ‘one dollar invested in the company generates value of more than one dollar’.

So, How Do We Calculate ROCE?

The formula for calculating the return on capital employed is:

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

Or for YuanShengTai Dairy Farm:

0.029 = CN¥151m ÷ (CN¥5.2b – CN¥491m) (Based on the trailing twelve months to June 2018.)

So, YuanShengTai Dairy Farm has an ROCE of 2.9%.

See our latest analysis for YuanShengTai Dairy Farm

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Does YuanShengTai Dairy Farm Have A Good ROCE?

When making comparisons between similar businesses, investors may find ROCE useful. Using our data, YuanShengTai Dairy Farm’s ROCE appears to be significantly below the 11% average in the Food industry. This performance is not ideal, as it suggests the company may not be deploying its capital as effectively as some competitors. Putting aside YuanShengTai Dairy Farm’s performance relative to its industry, its ROCE in absolute terms is poor – considering the risk of owning stocks compared to government bonds. There are potentially more appealing investments elsewhere.

As we can see, YuanShengTai Dairy Farm currently has an ROCE of 2.9%, less than the 8.7% it reported 3 years ago. So investors might consider if it has had issues recently.

SEHK:1431 Last Perf January 21st 19
SEHK:1431 Last Perf January 21st 19

When considering this metric, keep in mind that it is backwards looking, and not necessarily predictive. ROCE can be misleading for companies in cyclical industries, with returns looking impressive during the boom times, but very weak during the busts. This is because ROCE only looks at one year, instead of considering returns across a whole cycle. How cyclical is YuanShengTai Dairy Farm? You can see for yourself by looking at this free graph of past earnings, revenue and cash flow.

YuanShengTai Dairy Farm’s Current Liabilities And Their Impact On Its ROCE

Short term (or current) liabilities, are things like supplier invoices, overdrafts, or tax bills that need to be paid within 12 months. Due to the way the ROCE equation works, having large bills due in the near term can make it look as though a company has less capital employed, and thus a higher ROCE than usual. To counter this, investors can check if a company has high current liabilities relative to total assets.

YuanShengTai Dairy Farm has total liabilities of CN¥491m and total assets of CN¥5.2b. As a result, its current liabilities are equal to approximately 9.4% of its total assets. YuanShengTai Dairy Farm has a low level of current liabilities, which have a negligible impact on its already low ROCE.

The Bottom Line On YuanShengTai Dairy Farm’s ROCE

Nonetheless, there may be better places to invest your capital. Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

If you like to buy stocks alongside management, then you might just love this free list of companies. (Hint: insiders have been buying them).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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