What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So when we looked at XJ Electric (SZSE:000400) and its trend of ROCE, we really liked what we saw.

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. To calculate this metric for XJ Electric, this is the formula:

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

0.095 = CN¥1.2b ÷ (CN¥24b - CN¥11b) (Based on the trailing twelve months to September 2024).

Thus, XJ Electric has an ROCE of 9.5%. On its own that's a low return, but compared to the average of 5.7% generated by the Electrical industry, it's much better.

Above you can see how the current ROCE for XJ Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for XJ Electric .

What The Trend Of ROCE Can Tell Us

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 9.5%. The amount of capital employed has increased too, by 48%. So we're very much inspired by what we're seeing at XJ Electric thanks to its ability to profitably reinvest capital.

Another thing to note, XJ Electric has a high ratio of current liabilities to total assets of 46%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From XJ Electric's ROCE

To sum it up, XJ Electric has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 221% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if XJ Electric can keep these trends up, it could have a bright future ahead.

Like most companies, XJ Electric does come with some risks, and we've found 1 warning sign that you should be aware of.

While XJ Electric 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.