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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at DeHua TB New Decoration MaterialLtd's (SZSE:002043) ROCE trend, we were very happy with what we saw.

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. The formula for this calculation on DeHua TB New Decoration MaterialLtd is:

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

0.22 = CN¥696m ÷ (CN¥5.9b - CN¥2.7b) (Based on the trailing twelve months to September 2023).

So, DeHua TB New Decoration MaterialLtd has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Forestry industry average of 3.4%.

Check out our latest analysis for DeHua TB New Decoration MaterialLtd

In the above chart we have measured DeHua TB New Decoration MaterialLtd'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 report on analyst forecasts for the company.

What Can We Tell From DeHua TB New Decoration MaterialLtd's ROCE Trend?

In terms of DeHua TB New Decoration MaterialLtd's history of ROCE, it's quite impressive. Over the past five years, ROCE has remained relatively flat at around 22% and the business has deployed 76% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. You'll see this when looking at well operated businesses or favorable business models.

On a side note, DeHua TB New Decoration MaterialLtd's current liabilities are still rather high at 46% of total assets. 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 DeHua TB New Decoration MaterialLtd's ROCE

In short, we'd argue DeHua TB New Decoration MaterialLtd has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And long term investors would be thrilled with the 111% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 2 warning signs with DeHua TB New Decoration MaterialLtd and understanding these should be part of your investment process.

DeHua TB New Decoration MaterialLtd is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.