There Are Reasons To Feel Uneasy About Li Ning's (HKG:2331) Returns On Capital

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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Li Ning (HKG:2331) and its ROCE trend, we weren't exactly thrilled.

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What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Li Ning, this is the formula:

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

0.14 = CN¥3.9b ÷ (CN¥36b - CN¥7.6b) (Based on the trailing twelve months to December 2024).

Therefore, Li Ning has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Luxury industry average of 12%.

View our latest analysis for Li Ning

In the above chart we have measured Li Ning's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Li Ning .

The Trend Of ROCE

When we looked at the ROCE trend at Li Ning, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 19% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Li Ning has done well to pay down its current liabilities to 21% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Li Ning's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 33% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Li Ning has the makings of a multi-bagger.

Li Ning does have some risks though, and we've spotted 1 warning sign for Li Ning that you might be interested in.

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.