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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. So when we looked at Hubei Jiuzhiyang Infrared System (SZSE:300516) and its trend of ROCE, we really liked 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 Hubei Jiuzhiyang Infrared System is:

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

0.065 = CN¥86m ÷ (CN¥1.8b - CN¥471m) (Based on the trailing twelve months to March 2024).

Therefore, Hubei Jiuzhiyang Infrared System has an ROCE of 6.5%. On its own that's a low return, but compared to the average of 5.4% generated by the Electronic industry, it's much better.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Hubei Jiuzhiyang Infrared System's past further, check out this free graph covering Hubei Jiuzhiyang Infrared System's past earnings, revenue and cash flow.

How Are Returns Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 6.5%. The amount of capital employed has increased too, by 29%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 26% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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.

The Bottom Line On Hubei Jiuzhiyang Infrared System's ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Hubei Jiuzhiyang Infrared System has. Given the stock has declined 23% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

Like most companies, Hubei Jiuzhiyang Infrared System does come with some risks, and we've found 1 warning sign that you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.