What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Sichuan Development Lomon's (SZSE:002312) returns on capital, so let's have a look.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Sichuan Development Lomon is:

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

0.035 = CN¥442m ÷ (CN¥17b - CN¥4.1b) (Based on the trailing twelve months to September 2023).

Therefore, Sichuan Development Lomon has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

Check out our latest analysis for Sichuan Development Lomon

In the above chart we have measured Sichuan Development Lomon'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 report for Sichuan Development Lomon.

The Trend Of ROCE

Sichuan Development Lomon has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 3.5% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Sichuan Development Lomon is utilizing 272% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 24% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Sichuan Development Lomon's ROCE

In summary, it's great to see that Sichuan Development Lomon has managed to break into profitability and is continuing to reinvest in its business. And a remarkable 108% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

On a final note, we found 3 warning signs for Sichuan Development Lomon (1 doesn't sit too well with us) you should be aware of.

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.