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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Sichuan Dawn Precision TechnologyLtd (SZSE:300780), we don't think it's current trends fit the mold of a multi-bagger.

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 Sichuan Dawn Precision TechnologyLtd, this is the formula:

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

0.024 = CN¥44m ÷ (CN¥2.1b - CN¥214m) (Based on the trailing twelve months to September 2023).

Therefore, Sichuan Dawn Precision TechnologyLtd has an ROCE of 2.4%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.2%.

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

The Trend Of ROCE

In terms of Sichuan Dawn Precision TechnologyLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 16%, but since then they've fallen to 2.4%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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, Sichuan Dawn Precision TechnologyLtd has done well to pay down its current liabilities to 10% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Sichuan Dawn Precision TechnologyLtd's ROCE

We're a bit apprehensive about Sichuan Dawn Precision TechnologyLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Despite the concerning underlying trends, the stock has actually gained 5.1% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.

If you want to know some of the risks facing Sichuan Dawn Precision TechnologyLtd we've found 4 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

While Sichuan Dawn Precision TechnologyLtd 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.