If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 Xiangyang Changyuandonggu Industry (SHSE:603950) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Xiangyang Changyuandonggu Industry, this is the formula:

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

0.057 = CN¥202m ÷ (CN¥4.7b - CN¥1.2b) (Based on the trailing twelve months to March 2024).

Thus, Xiangyang Changyuandonggu Industry has an ROCE of 5.7%. On its own, that's a low figure but it's around the 6.9% average generated by the Auto Components industry.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xiangyang Changyuandonggu Industry's ROCE against it's prior returns. If you're interested in investigating Xiangyang Changyuandonggu Industry's past further, check out this free graph covering Xiangyang Changyuandonggu Industry's past earnings, revenue and cash flow.

What Does the ROCE Trend For Xiangyang Changyuandonggu Industry Tell Us?

In terms of Xiangyang Changyuandonggu Industry's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 5.7%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Xiangyang Changyuandonggu Industry has decreased its current liabilities to 25% 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.

The Bottom Line On Xiangyang Changyuandonggu Industry'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 Xiangyang Changyuandonggu Industry. However, total returns to shareholders over the last three years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know more about Xiangyang Changyuandonggu Industry, we've spotted 3 warning signs, and 2 of them can't be ignored.

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.

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