What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. In light of that, when we looked at Hangzhou Star Shuaier Electric Appliance (SZSE:002860) and its ROCE trend, we weren't exactly thrilled.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Hangzhou Star Shuaier Electric Appliance:

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

0.093 = CN¥207m ÷ (CN¥3.2b - CN¥970m) (Based on the trailing twelve months to June 2024).

Therefore, Hangzhou Star Shuaier Electric Appliance has an ROCE of 9.3%. On its own that's a low return, but compared to the average of 5.9% generated by the Electrical industry, it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hangzhou Star Shuaier Electric Appliance's ROCE against it's prior returns. If you're interested in investigating Hangzhou Star Shuaier Electric Appliance's past further, check out this free graph covering Hangzhou Star Shuaier Electric Appliance's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Hangzhou Star Shuaier Electric Appliance, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 9.3% from 12% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hangzhou Star Shuaier Electric Appliance's current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 9.3%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

What We Can Learn From Hangzhou Star Shuaier Electric Appliance's ROCE

In summary, we're somewhat concerned by Hangzhou Star Shuaier Electric Appliance's diminishing returns on increasing amounts of capital. In spite of that, the stock has delivered a 10% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing to note, we've identified 1 warning sign with Hangzhou Star Shuaier Electric Appliance and understanding this should be part of your investment process.

While Hangzhou Star Shuaier Electric Appliance isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.