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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Zhejiang Huakang Pharmaceutical (SHSE:605077), it didn't seem to tick all of these boxes.

Understanding 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. The formula for this calculation on Zhejiang Huakang Pharmaceutical is:

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

0.072 = CN¥391m ÷ (CN¥6.3b - CN¥855m) (Based on the trailing twelve months to March 2024).

Thus, Zhejiang Huakang Pharmaceutical has an ROCE of 7.2%. In absolute terms, that's a low return but it's around the Food industry average of 7.6%.

In the above chart we have measured Zhejiang Huakang Pharmaceutical'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 Zhejiang Huakang Pharmaceutical .

So How Is Zhejiang Huakang Pharmaceutical's ROCE Trending?

On the surface, the trend of ROCE at Zhejiang Huakang Pharmaceutical doesn't inspire confidence. To be more specific, ROCE has fallen from 38% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Zhejiang Huakang Pharmaceutical has decreased its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. 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 Zhejiang Huakang Pharmaceutical'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 Zhejiang Huakang Pharmaceutical. And there could be an opportunity here if other metrics look good too, because the stock has declined 30% in 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 more about Zhejiang Huakang Pharmaceutical, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.

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.

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