If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Although, when we looked at Zhejiang Jinghua Laser TechnologyLtd (SHSE:603607), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Zhejiang Jinghua Laser TechnologyLtd, this is the formula:

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

0.069 = CN¥68m ÷ (CN¥1.4b - CN¥458m) (Based on the trailing twelve months to September 2023).

Thus, Zhejiang Jinghua Laser TechnologyLtd has an ROCE of 6.9%. On its own that's a low return, but compared to the average of 3.4% generated by the Forestry industry, it's much better.

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

What Can We Tell From Zhejiang Jinghua Laser TechnologyLtd's ROCE Trend?

On the surface, the trend of ROCE at Zhejiang Jinghua Laser TechnologyLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.9% from 11% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

Our Take On Zhejiang Jinghua Laser TechnologyLtd's ROCE

We're a bit apprehensive about Zhejiang Jinghua Laser TechnologyLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 7.0% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a separate note, we've found 1 warning sign for Zhejiang Jinghua Laser TechnologyLtd you'll probably want to know about.

While Zhejiang Jinghua Laser TechnologyLtd 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.