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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Offshore Oil EngineeringLtd (SHSE:600583) and its trend of ROCE, we really liked what we saw.

What Is Return On Capital Employed (ROCE)?

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 Offshore Oil EngineeringLtd, this is the formula:

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

0.051 = CN¥1.4b ÷ (CN¥44b - CN¥16b) (Based on the trailing twelve months to March 2024).

Therefore, Offshore Oil EngineeringLtd has an ROCE of 5.1%. In absolute terms, that's a low return and it also under-performs the Energy Services industry average of 6.5%.

In the above chart we have measured Offshore Oil EngineeringLtd'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 analyst report for Offshore Oil EngineeringLtd .

How Are Returns Trending?

The fact that Offshore Oil EngineeringLtd is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 5.1% which is a sight for sore eyes. Not only that, but the company is utilizing 21% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 37% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

In Conclusion...

Long story short, we're delighted to see that Offshore Oil EngineeringLtd's reinvestment activities have paid off and the company is now profitable. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 13% to shareholders. So with that in mind, we think the stock deserves further research.

Offshore Oil EngineeringLtd does have some risks though, and we've spotted 1 warning sign for Offshore Oil EngineeringLtd that you might be interested in.

While Offshore Oil EngineeringLtd 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com