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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Mesnac (SZSE:002073) and its trend of ROCE, we really liked what we saw.

Return On Capital Employed (ROCE): What Is It?

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 Mesnac is:

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

0.071 = CN¥479m ÷ (CN¥17b - CN¥10b) (Based on the trailing twelve months to June 2024).

Therefore, Mesnac has an ROCE of 7.1%. In absolute terms, that's a low return, but it's much better than the Machinery industry average of 5.7%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Mesnac's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Mesnac.

How Are Returns Trending?

We're delighted to see that Mesnac is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 7.1% on its capital. In addition to that, Mesnac is employing 39% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

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. Effectively this means that suppliers or short-term creditors are now funding 60% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.

The Bottom Line On Mesnac's ROCE

In summary, it's great to see that Mesnac has managed to break into profitability and is continuing to reinvest in its business. Since the stock has only returned 2.9% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.

One more thing to note, we've identified 2 warning signs with Mesnac and understanding them should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.