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. 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 Guizhou Zhenhua Fengguang Semiconductor (SHSE:688439), it didn't seem to tick all of these boxes.

What Is 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 Guizhou Zhenhua Fengguang Semiconductor is:

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

0.13 = CN¥637m ÷ (CN¥5.6b - CN¥542m) (Based on the trailing twelve months to March 2024).

Thus, Guizhou Zhenhua Fengguang Semiconductor has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 4.2% it's much better.

In the above chart we have measured Guizhou Zhenhua Fengguang Semiconductor'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 Guizhou Zhenhua Fengguang Semiconductor .

The Trend Of ROCE

When we looked at the ROCE trend at Guizhou Zhenhua Fengguang Semiconductor, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 21% five years ago. 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, Guizhou Zhenhua Fengguang Semiconductor has decreased its current liabilities to 9.8% 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.

What We Can Learn From Guizhou Zhenhua Fengguang Semiconductor's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Guizhou Zhenhua Fengguang Semiconductor is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 41% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you want to know some of the risks facing Guizhou Zhenhua Fengguang Semiconductor we've found 2 warning signs (1 is concerning!) that you should be aware of before investing here.

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.

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