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. 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. However, after briefly looking over the numbers, we don't think Dongguan Aohai Technology (SZSE:002993) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Dongguan Aohai Technology is:

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

0.077 = CN¥391m ÷ (CN¥8.4b - CN¥3.3b) (Based on the trailing twelve months to December 2023).

Therefore, Dongguan Aohai Technology has an ROCE of 7.7%. In absolute terms, that's a low return, but it's much better than the Tech industry average of 5.3%.

In the above chart we have measured Dongguan Aohai Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Dongguan Aohai Technology .

What Does the ROCE Trend For Dongguan Aohai Technology Tell Us?

On the surface, the trend of ROCE at Dongguan Aohai Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.7% from 18% five years ago. 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 related note, Dongguan Aohai Technology has decreased its current liabilities to 40% 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 Dongguan Aohai Technology's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Dongguan Aohai Technology. These growth trends haven't led to growth returns though, since the stock has fallen 12% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know about the risks facing Dongguan Aohai Technology, we've discovered 1 warning sign that 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.