What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Speaking of which, we noticed some great changes in Shanghai Dragon's (SHSE:600630) returns on capital, so let's have a look.

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 Shanghai Dragon:

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

0.043 = CN¥37m ÷ (CN¥1.7b - CN¥785m) (Based on the trailing twelve months to September 2024).

Therefore, Shanghai Dragon has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 6.5%.

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're interested in investigating Shanghai Dragon's past further, check out this free graph covering Shanghai Dragon's past earnings, revenue and cash flow.

The Trend Of ROCE

While the ROCE is still rather low for Shanghai Dragon, we're glad to see it heading in the right direction. The data shows that returns on capital have increased by 61% over the trailing five years. The company is now earning CN¥0.04 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 53% less than it was five years ago, which can be indicative of a business that's improving its efficiency. Shanghai Dragon may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

Another thing to note, Shanghai Dragon has a high ratio of current liabilities to total assets of 47%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

From what we've seen above, Shanghai Dragon has managed to increase it's returns on capital all the while reducing it's capital base. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 55% return over the last five years. Therefore, we think it would be worth your time to check if these trends are going to continue.

Shanghai Dragon does have some risks though, and we've spotted 1 warning sign for Shanghai Dragon that you might be interested in.

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.