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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Hunan Yujing MachineryLtd (SZSE:002943) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Hunan Yujing MachineryLtd, this is the formula:

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

0.077 = CN¥120m ÷ (CN¥2.9b - CN¥1.3b) (Based on the trailing twelve months to September 2023).

Therefore, Hunan Yujing MachineryLtd has an ROCE of 7.7%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 6.1%.

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

So How Is Hunan Yujing MachineryLtd's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 23% five years ago, while the business's capital employed increased by 156%. Usually this isn't ideal, but given Hunan Yujing MachineryLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Hunan Yujing MachineryLtd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 46%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line

While returns have fallen for Hunan Yujing MachineryLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 34% in the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a separate note, we've found 1 warning sign for Hunan Yujing MachineryLtd you'll probably want to know about.

While Hunan Yujing MachineryLtd 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.