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. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Zhejiang Sanmei Chemical IndustryLtd (SHSE:603379) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Zhejiang Sanmei Chemical IndustryLtd is:

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

0.10 = CN¥662m ÷ (CN¥7.0b - CN¥634m) (Based on the trailing twelve months to September 2024).

Therefore, Zhejiang Sanmei Chemical IndustryLtd has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.

Above you can see how the current ROCE for Zhejiang Sanmei Chemical IndustryLtd 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 Zhejiang Sanmei Chemical IndustryLtd for free.

How Are Returns Trending?

When we looked at the ROCE trend at Zhejiang Sanmei Chemical IndustryLtd, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 10%. 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 may take some time before the company starts to see any change in earnings from these investments.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Zhejiang Sanmei Chemical IndustryLtd's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 48% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we found 2 warning signs for Zhejiang Sanmei Chemical IndustryLtd (1 shouldn't be ignored) you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.