What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Xiamen Leading Optics (SHSE:605118) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Xiamen Leading Optics:

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

0.092 = CN¥141m ÷ (CN¥1.7b - CN¥120m) (Based on the trailing twelve months to March 2024).

So, Xiamen Leading Optics has an ROCE of 9.2%. On its own that's a low return, but compared to the average of 5.2% generated by the Electronic industry, it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xiamen Leading Optics' ROCE against it's prior returns. If you'd like to look at how Xiamen Leading Optics has performed in the past in other metrics, you can view this free graph of Xiamen Leading Optics' past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Xiamen Leading Optics' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 42%, but since then they've fallen to 9.2%. 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'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, Xiamen Leading Optics has decreased its current liabilities to 7.2% of total assets. So we could link some of this to the decrease in ROCE. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Xiamen Leading Optics' ROCE

Bringing it all together, while we're somewhat encouraged by Xiamen Leading Optics' reinvestment in its own business, we're aware that returns are shrinking. And investors may be recognizing these trends since the stock has only returned a total of 8.8% to shareholders over the last three years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

On a final note, we found 2 warning signs for Xiamen Leading Optics (1 is significant) you should be aware of.

While Xiamen Leading Optics 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com