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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Shanghai Luoman Lighting Technologies (SHSE:605289) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shanghai Luoman Lighting Technologies, this is the formula:

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

0.036 = CN¥53m ÷ (CN¥1.9b - CN¥485m) (Based on the trailing twelve months to September 2023).

Therefore, Shanghai Luoman Lighting Technologies has an ROCE of 3.6%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.8%.

See our latest analysis for Shanghai Luoman Lighting Technologies

Above you can see how the current ROCE for Shanghai Luoman Lighting Technologies compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is Shanghai Luoman Lighting Technologies' ROCE Trending?

In terms of Shanghai Luoman Lighting Technologies' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 29%, but since then they've fallen to 3.6%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Shanghai Luoman Lighting Technologies has done well to pay down its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

The Bottom Line On Shanghai Luoman Lighting Technologies' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Shanghai Luoman Lighting Technologies is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 49% to shareholders over the last year. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Shanghai Luoman Lighting Technologies does have some risks though, and we've spotted 1 warning sign for Shanghai Luoman Lighting Technologies that you might be interested in.

While Shanghai Luoman Lighting Technologies 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.