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. 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 Colorlight Cloud Tech (SZSE:301391), it didn't seem to tick all of these boxes.

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 Colorlight Cloud Tech, this is the formula:

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

0.034 = CN¥74m ÷ (CN¥2.6b - CN¥452m) (Based on the trailing twelve months to September 2024).

So, Colorlight Cloud Tech has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.5%.

Above you can see how the current ROCE for Colorlight Cloud Tech compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Colorlight Cloud Tech .

What Does the ROCE Trend For Colorlight Cloud Tech Tell Us?

When we looked at the ROCE trend at Colorlight Cloud Tech, we didn't gain much confidence. Around five years ago the returns on capital were 58%, but since then they've fallen to 3.4%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Colorlight Cloud Tech has decreased its current liabilities to 17% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Colorlight Cloud Tech's ROCE

To conclude, we've found that Colorlight Cloud Tech is reinvesting in the business, but returns have been falling. And in the last year, the stock has given away 48% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

If you want to know some of the risks facing Colorlight Cloud Tech we've found 4 warning signs (1 is a bit concerning!) that you should be aware of before investing here.

While Colorlight Cloud Tech 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.