If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Speaking of which, we noticed some great changes in China Security's (SHSE:600654) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

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 China Security, this is the formula:

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

0.014 = CN¥27m ÷ (CN¥3.6b - CN¥1.7b) (Based on the trailing twelve months to September 2024).

Thus, China Security has an ROCE of 1.4%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.8%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Security's ROCE against it's prior returns. If you'd like to look at how China Security has performed in the past in other metrics, you can view this free graph of China Security's past earnings, revenue and cash flow.

How Are Returns Trending?

The fact that China Security 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 1.4% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, China Security is utilizing 222% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 47%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

What We Can Learn From China Security's ROCE

Overall, China Security gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you want to continue researching China Security, you might be interested to know about the 1 warning sign that our analysis has discovered.

While China Security 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.