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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Jinhong GasLtd (SHSE:688106) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Jinhong GasLtd, this is the formula:

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

0.066 = CN¥347m ÷ (CN¥6.7b - CN¥1.4b) (Based on the trailing twelve months to June 2024).

Thus, Jinhong GasLtd has an ROCE of 6.6%. On its own that's a low return, but compared to the average of 5.5% generated by the Chemicals industry, it's much better.

In the above chart we have measured Jinhong GasLtd's 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 Jinhong GasLtd for free.

How Are Returns Trending?

Unfortunately, the trend isn't great with ROCE falling from 19% five years ago, while capital employed has grown 400%. Usually this isn't ideal, but given Jinhong GasLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Jinhong GasLtd might not have received a full period of earnings contribution from it. Additionally, we found that Jinhong GasLtd's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

On a side note, Jinhong GasLtd has done well to pay down its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Jinhong GasLtd. However, despite the promising trends, the stock has fallen 31% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Jinhong GasLtd does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is potentially serious...

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.