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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Yantai Zhenghai Magnetic Material's (SZSE:300224) returns on capital, so let's have a look.

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 Yantai Zhenghai Magnetic Material is:

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

0.088 = CN¥469m ÷ (CN¥8.5b - CN¥3.2b) (Based on the trailing twelve months to March 2024).

So, Yantai Zhenghai Magnetic Material has an ROCE of 8.8%. On its own that's a low return, but compared to the average of 6.0% generated by the Electrical industry, it's much better.

Above you can see how the current ROCE for Yantai Zhenghai Magnetic Material compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Yantai Zhenghai Magnetic Material .

So How Is Yantai Zhenghai Magnetic Material's ROCE Trending?

Yantai Zhenghai Magnetic Material has recently broken into profitability so their prior investments seem to be paying off. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 8.8% on its capital. Not only that, but the company is utilizing 93% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 37% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Yantai Zhenghai Magnetic Material's ROCE

Overall, Yantai Zhenghai Magnetic Material gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Considering the stock has delivered 25% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.

On a separate note, we've found 1 warning sign for Yantai Zhenghai Magnetic Material you'll probably want to know about.

While Yantai Zhenghai Magnetic Material isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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