What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of Hongfa Technology (SHSE:600885) looks decent, right now, so lets see what the trend of returns can tell us.

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. To calculate this metric for Hongfa Technology, this is the formula:

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

0.16 = CN¥2.3b ÷ (CN¥18b - CN¥3.8b) (Based on the trailing twelve months to March 2024).

So, Hongfa Technology has an ROCE of 16%. On its own, that's a standard return, however it's much better than the 6.0% generated by the Electrical industry.

In the above chart we have measured Hongfa Technology's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hongfa Technology .

What Can We Tell From Hongfa Technology's ROCE Trend?

While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 16% and the business has deployed 122% more capital into its operations. Since 16% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 21% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.

Our Take On Hongfa Technology's ROCE

The main thing to remember is that Hongfa Technology has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 68% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Like most companies, Hongfa Technology does come with some risks, and we've found 1 warning sign that you should be aware of.

While Hongfa Technology 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