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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Lier ChemicalLTD (SZSE:002258), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. To calculate this metric for Lier ChemicalLTD, this is the formula:

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

0.12 = CN¥1.3b ÷ (CN¥14b - CN¥3.1b) (Based on the trailing twelve months to September 2023).

Therefore, Lier ChemicalLTD has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.

See our latest analysis for Lier ChemicalLTD

Above you can see how the current ROCE for Lier ChemicalLTD compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Lier ChemicalLTD.

So How Is Lier ChemicalLTD's ROCE Trending?

We weren't thrilled with the trend because Lier ChemicalLTD's ROCE has reduced by 41% over the last five years, while the business employed 187% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Lier ChemicalLTD's earnings and if they change as a result from the capital raise.

On a related note, Lier ChemicalLTD has decreased its current liabilities to 22% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Lier ChemicalLTD's ROCE

We're a bit apprehensive about Lier ChemicalLTD because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 37% return to shareholders who held over the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you'd like to know more about Lier ChemicalLTD, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.

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.