What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Xiamen Leading Optics (SHSE:605118) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Xiamen Leading Optics:

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

0.095 = CN¥142m ÷ (CN¥1.7b - CN¥212m) (Based on the trailing twelve months to June 2024).

Therefore, Xiamen Leading Optics has an ROCE of 9.5%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.4%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Xiamen Leading Optics' past further, check out this free graph covering Xiamen Leading Optics' past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Xiamen Leading Optics' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 9.5% from 37% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Xiamen Leading Optics has decreased its current liabilities to 12% of total assets. So we could link some of this to the decrease in ROCE. 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 Xiamen Leading Optics' ROCE

To conclude, we've found that Xiamen Leading Optics is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 16% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Xiamen Leading Optics (of which 1 shouldn't be ignored!) that you should know about.

While Xiamen Leading Optics 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.