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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Shenzhen Neoway TechnologyLtd (SHSE:688159) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. To calculate this metric for Shenzhen Neoway TechnologyLtd, this is the formula:

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

0.045 = CN¥38m ÷ (CN¥1.7b - CN¥875m) (Based on the trailing twelve months to March 2024).

Therefore, Shenzhen Neoway TechnologyLtd has an ROCE of 4.5%. On its own, that's a low figure but it's around the 3.9% average generated by the Communications industry.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shenzhen Neoway TechnologyLtd.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shenzhen Neoway TechnologyLtd, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.5% from 10% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 51%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.5%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Shenzhen Neoway TechnologyLtd's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shenzhen Neoway TechnologyLtd. In light of this, the stock has only gained 11% over the last three years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

If you want to know some of the risks facing Shenzhen Neoway TechnologyLtd we've found 2 warning signs (1 is concerning!) that you should be aware of before investing here.

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.

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