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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Hangzhou Kelin Electric (SHSE:688611), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

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 Hangzhou Kelin Electric, this is the formula:

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

0.059 = CN¥51m ÷ (CN¥1.1b - CN¥177m) (Based on the trailing twelve months to June 2024).

Therefore, Hangzhou Kelin Electric has an ROCE of 5.9%. Even though it's in line with the industry average of 5.9%, it's still a low return by itself.

Above you can see how the current ROCE for Hangzhou Kelin Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Hangzhou Kelin Electric for free.

So How Is Hangzhou Kelin Electric's ROCE Trending?

When we looked at the ROCE trend at Hangzhou Kelin Electric, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.9% from 44% 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.

On a related note, Hangzhou Kelin Electric has decreased its current liabilities to 17% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Hangzhou Kelin Electric is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 34% over the last three years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

One final note, you should learn about the 3 warning signs we've spotted with Hangzhou Kelin Electric (including 2 which can't be ignored) .

While Hangzhou Kelin Electric 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.

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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.