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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Jiangsu Tongli Risheng Machinery (SHSE:605286) 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 Jiangsu Tongli Risheng Machinery, this is the formula:

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

0.13 = CN¥270m ÷ (CN¥3.7b - CN¥1.6b) (Based on the trailing twelve months to December 2023).

Therefore, Jiangsu Tongli Risheng Machinery has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Machinery industry average of 5.9% it's much better.

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Jiangsu Tongli Risheng Machinery.

The Trend Of ROCE

In terms of Jiangsu Tongli Risheng Machinery's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 13% from 27% five years ago. However it looks like Jiangsu Tongli Risheng Machinery might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

Another thing to note, Jiangsu Tongli Risheng Machinery has a high ratio of current liabilities to total assets of 43%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Jiangsu Tongli Risheng Machinery's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 6.2% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

On a final note, we've found 1 warning sign for Jiangsu Tongli Risheng Machinery that we think you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.