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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. With that in mind, we've noticed some promising trends at XJ Electric (SZSE:000400) so let's look a bit deeper.

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. Analysts use this formula to calculate it for XJ Electric:

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

0.093 = CN¥1.1b ÷ (CN¥21b - CN¥9.0b) (Based on the trailing twelve months to September 2023).

Therefore, XJ Electric has an ROCE of 9.3%. On its own that's a low return, but compared to the average of 6.3% generated by the Electrical industry, it's much better.

See our latest analysis for XJ Electric

In the above chart we have measured XJ Electric's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For XJ Electric Tell Us?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 9.3%. Basically the business is earning more per dollar of capital invested and in addition to that, 44% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

Another thing to note, XJ Electric has a high ratio of current liabilities to total assets of 43%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what XJ Electric has. And a remarkable 109% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if XJ Electric can keep these trends up, it could have a bright future ahead.

Like most companies, XJ Electric does come with some risks, and we've found 1 warning sign that you should be aware of.

While XJ Electric isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.