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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Shanghai Shentong MetroLtd's (SHSE:600834) returns on capital, so let's have a look.

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

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. Analysts use this formula to calculate it for Shanghai Shentong MetroLtd:

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

0.045 = CN¥82m ÷ (CN¥2.4b - CN¥577m) (Based on the trailing twelve months to June 2024).

Thus, Shanghai Shentong MetroLtd has an ROCE of 4.5%. Even though it's in line with the industry average of 4.3%, it's still a low return by itself.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Shentong MetroLtd's ROCE against it's prior returns. If you'd like to look at how Shanghai Shentong MetroLtd has performed in the past in other metrics, you can view this free graph of Shanghai Shentong MetroLtd's past earnings, revenue and cash flow.

What Can We Tell From Shanghai Shentong MetroLtd's ROCE Trend?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The figures show that over the last five years, returns on capital have grown by 106%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Shanghai Shentong MetroLtd appears to been achieving more with less, since the business is using 30% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

Our Take On Shanghai Shentong MetroLtd's ROCE

In a nutshell, we're pleased to see that Shanghai Shentong MetroLtd has been able to generate higher returns from less capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 20% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing to note, we've identified 1 warning sign with Shanghai Shentong MetroLtd and understanding it should be part of your investment process.

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.