What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Shanghai Pret Composites' (SZSE:002324) returns on capital, so let's have a look.

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. Analysts use this formula to calculate it for Shanghai Pret Composites:

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

0.096 = CN¥556m ÷ (CN¥11b - CN¥5.7b) (Based on the trailing twelve months to September 2023).

Therefore, Shanghai Pret Composites has an ROCE of 9.6%. On its own that's a low return, but compared to the average of 5.8% generated by the Chemicals industry, it's much better.

See our latest analysis for Shanghai Pret Composites

In the above chart we have measured Shanghai Pret Composites' 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 Shanghai Pret Composites here for free.

What Can We Tell From Shanghai Pret Composites' ROCE Trend?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 9.6%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 138%. 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. Essentially the business now has suppliers or short-term creditors funding about 50% of its operations, which isn't ideal. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Key Takeaway

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 Shanghai Pret Composites has. Since the stock has returned a staggering 286% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Shanghai Pret Composites can keep these trends up, it could have a bright future ahead.

One more thing, we've spotted 1 warning sign facing Shanghai Pret Composites that you might find interesting.

While Shanghai Pret Composites 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.