Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. That's why when we briefly looked at Zhejiang Xinao Textiles' (SHSE:603889) ROCE trend, we were pretty happy with what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Zhejiang Xinao Textiles is:

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

0.11 = CN¥439m ÷ (CN¥5.7b - CN¥1.8b) (Based on the trailing twelve months to September 2023).

So, Zhejiang Xinao Textiles has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 5.0% it's much better.

In the above chart we have measured Zhejiang Xinao Textiles' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Zhejiang Xinao Textiles here for free.

What Does the ROCE Trend For Zhejiang Xinao Textiles Tell Us?

The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 11% for the last five years, and the capital employed within the business has risen 66% in that time. 11% is a pretty standard return, and it provides some comfort knowing that Zhejiang Xinao Textiles has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 32% of total assets, this reported ROCE would probably be less than11% because total capital employed would be higher.The 11% ROCE could be even lower if current liabilities weren't 32% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

The Key Takeaway

The main thing to remember is that Zhejiang Xinao Textiles has proven its ability to continually reinvest at respectable rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

Zhejiang Xinao Textiles does have some risks, we noticed 2 warning signs (and 1 which can't be ignored) we think you should know about.

While Zhejiang Xinao Textiles 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.