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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at China Southern Power Grid Energy Efficiency & Clean Energy (SZSE:003035) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for China Southern Power Grid Energy Efficiency & Clean Energy, this is the formula:

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

0.06 = CN¥816m ÷ (CN¥17b - CN¥3.4b) (Based on the trailing twelve months to June 2023).

Therefore, China Southern Power Grid Energy Efficiency & Clean Energy has an ROCE of 6.0%. In absolute terms, that's a low return but it's around the Commercial Services industry average of 5.3%.

See our latest analysis for China Southern Power Grid Energy Efficiency & Clean Energy

In the above chart we have measured China Southern Power Grid Energy Efficiency & Clean Energy'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 report on analyst forecasts for the company.

How Are Returns Trending?

In terms of China Southern Power Grid Energy Efficiency & Clean Energy's historical ROCE trend, it doesn't exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 6.0% and the business has deployed 267% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 20% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Bottom Line

In summary, China Southern Power Grid Energy Efficiency & Clean Energy has simply been reinvesting capital and generating the same low rate of return as before. Additionally, the stock's total return to shareholders over the last year has been flat, which isn't too surprising. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a final note, we've found 1 warning sign for China Southern Power Grid Energy Efficiency & Clean Energy that we think you should be aware of.

While China Southern Power Grid Energy Efficiency & Clean Energy isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.