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. So on that note, Shenzhen Kaifa Technology (SZSE:000021) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Shenzhen Kaifa Technology:

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

0.068 = CN¥1.1b ÷ (CN¥29b - CN¥13b) (Based on the trailing twelve months to September 2024).

Thus, Shenzhen Kaifa Technology has an ROCE of 6.8%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Kaifa Technology's ROCE against it's prior returns. If you're interested in investigating Shenzhen Kaifa Technology's past further, check out this free graph covering Shenzhen Kaifa Technology's past earnings, revenue and cash flow.

The Trend Of ROCE

We're delighted to see that Shenzhen Kaifa Technology is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 6.8% which is a sight for sore eyes. In addition to that, Shenzhen Kaifa Technology is employing 134% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

On a related note, the company's ratio of current liabilities to total assets has decreased to 45%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

In Conclusion...

Long story short, we're delighted to see that Shenzhen Kaifa Technology's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 139% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

One more thing to note, we've identified 1 warning sign with Shenzhen Kaifa Technology and understanding this should be part of your investment process.

While Shenzhen Kaifa Technology may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.