What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Inner Mongolia Baotou Steel Union (SHSE:600010) and its ROCE trend, we weren't exactly thrilled.

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 Inner Mongolia Baotou Steel Union is:

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

0.027 = CN¥2.3b ÷ (CN¥154b - CN¥69b) (Based on the trailing twelve months to September 2023).

Thus, Inner Mongolia Baotou Steel Union has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 6.3%.

See our latest analysis for Inner Mongolia Baotou Steel Union

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 Inner Mongolia Baotou Steel Union's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Inner Mongolia Baotou Steel Union, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 2.7% from 10% 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, Inner Mongolia Baotou Steel Union has done well to pay down its current liabilities to 45% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 45% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

We're a bit apprehensive about Inner Mongolia Baotou Steel Union because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 3.1% in 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.

On a final note, we found 3 warning signs for Inner Mongolia Baotou Steel Union (2 are significant) you should be aware of.

While Inner Mongolia Baotou Steel Union 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.