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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Bichamp Cutting Technology (Hunan) (SZSE:002843) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Bichamp Cutting Technology (Hunan) is:

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

0.075 = CN¥128m ÷ (CN¥2.7b - CN¥1.0b) (Based on the trailing twelve months to September 2023).

Thus, Bichamp Cutting Technology (Hunan) has an ROCE of 7.5%. On its own, that's a low figure but it's around the 6.2% average generated by the Machinery industry.

See our latest analysis for Bichamp Cutting Technology (Hunan)

Above you can see how the current ROCE for Bichamp Cutting Technology (Hunan) 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.

What Can We Tell From Bichamp Cutting Technology (Hunan)'s ROCE Trend?

The returns on capital haven't changed much for Bichamp Cutting Technology (Hunan) in recent years. The company has consistently earned 7.5% for the last five years, and the capital employed within the business has risen 164% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 37% of total assets, this reported ROCE would probably be less than7.5% because total capital employed would be higher.The 7.5% ROCE could be even lower if current liabilities weren't 37% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

Our Take On Bichamp Cutting Technology (Hunan)'s ROCE

In summary, Bichamp Cutting Technology (Hunan) has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 281% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to know some of the risks facing Bichamp Cutting Technology (Hunan) we've found 3 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

While Bichamp Cutting Technology (Hunan) 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.