If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 Leader Harmonious Drive Systems (SHSE:688017), it didn't seem to tick all of these boxes.

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

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 Leader Harmonious Drive Systems is:

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

0.02 = CN¥45m ÷ (CN¥2.9b - CN¥652m) (Based on the trailing twelve months to March 2024).

So, Leader Harmonious Drive Systems has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.7%.

In the above chart we have measured Leader Harmonious Drive Systems' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Leader Harmonious Drive Systems for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Leader Harmonious Drive Systems doesn't inspire confidence. To be more specific, ROCE has fallen from 9.1% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Leader Harmonious Drive Systems' current liabilities have increased over the last five years to 23% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 2.0%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line On Leader Harmonious Drive Systems' ROCE

In summary, we're somewhat concerned by Leader Harmonious Drive Systems' diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 47% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Leader Harmonious Drive Systems, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Leader Harmonious Drive Systems 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.