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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Harbin Air ConditioningLtd (SHSE:600202) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. The formula for this calculation on Harbin Air ConditioningLtd is:

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

0.047 = CN¥69m ÷ (CN¥3.1b - CN¥1.6b) (Based on the trailing twelve months to March 2024).

Thus, Harbin Air ConditioningLtd has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Building industry average of 7.4%.

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

How Are Returns Trending?

On the surface, the trend of ROCE at Harbin Air ConditioningLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.7% from 9.9% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Harbin Air ConditioningLtd has decreased its current liabilities to 53% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Harbin Air ConditioningLtd. These growth trends haven't led to growth returns though, since the stock has fallen 31% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Harbin Air ConditioningLtd does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit concerning...

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.