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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Changzhou Xiangming Intelligent Drive System (SZSE:301226), it didn't seem to tick all of these boxes.

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

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 Changzhou Xiangming Intelligent Drive System, this is the formula:

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

0.057 = CN¥52m ÷ (CN¥1.0b - CN¥141m) (Based on the trailing twelve months to September 2023).

Thus, Changzhou Xiangming Intelligent Drive System has an ROCE of 5.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.3%.

Check out our latest analysis for Changzhou Xiangming Intelligent Drive System

In the above chart we have measured Changzhou Xiangming Intelligent Drive System'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 Changzhou Xiangming Intelligent Drive System.

What Can We Tell From Changzhou Xiangming Intelligent Drive System's ROCE Trend?

When we looked at the ROCE trend at Changzhou Xiangming Intelligent Drive System, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.7% from 14% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Changzhou Xiangming Intelligent Drive System has decreased its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 On Changzhou Xiangming Intelligent Drive System's ROCE

In summary, Changzhou Xiangming Intelligent Drive System is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last year has been flat. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Changzhou Xiangming Intelligent Drive System, we've discovered 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.