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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Western Metal Materials (SZSE:002149) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Western Metal Materials, this is the formula:

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

0.064 = CN¥250m ÷ (CN¥6.9b - CN¥2.9b) (Based on the trailing twelve months to March 2024).

Thus, Western Metal Materials has an ROCE of 6.4%. On its own, that's a low figure but it's around the 6.7% average generated by the Metals and Mining industry.

In the above chart we have measured Western Metal Materials' 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 Western Metal Materials .

What Can We Tell From Western Metal Materials' ROCE Trend?

There are better returns on capital out there than what we're seeing at Western Metal Materials. Over the past five years, ROCE has remained relatively flat at around 6.4% and the business has deployed 62% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

On a side note, Western Metal Materials' current liabilities are still rather high at 43% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

As we've seen above, Western Metal Materials' returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 66% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing, we've spotted 2 warning signs facing Western Metal Materials that you might find interesting.

While Western Metal Materials 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com