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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. So on that note, Yifeng Pharmacy Chain (SHSE:603939) looks quite promising in regards to its trends of return on capital.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Yifeng Pharmacy Chain, this is the formula:

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

0.17 = CN¥2.1b ÷ (CN¥22b - CN¥9.7b) (Based on the trailing twelve months to September 2023).

Therefore, Yifeng Pharmacy Chain has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 6.9% generated by the Consumer Retailing industry.

Above you can see how the current ROCE for Yifeng Pharmacy Chain 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 Yifeng Pharmacy Chain for free.

What Does the ROCE Trend For Yifeng Pharmacy Chain Tell Us?

We like the trends that we're seeing from Yifeng Pharmacy Chain. Over the last five years, returns on capital employed have risen substantially to 17%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 206%. 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, Yifeng Pharmacy Chain has a high ratio of current liabilities to total assets of 44%. 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.

What We Can Learn From Yifeng Pharmacy Chain's ROCE

All in all, it's terrific to see that Yifeng Pharmacy Chain is reaping the rewards from prior investments and is growing its capital base. Since the stock has returned a solid 95% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

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

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.