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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 briefly looking over the numbers, we don't think China Machinery Huanyu Certification and Inspection (SZSE:301508) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on China Machinery Huanyu Certification and Inspection is:

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

0.055 = CN¥119m ÷ (CN¥2.5b - CN¥301m) (Based on the trailing twelve months to September 2024).

Therefore, China Machinery Huanyu Certification and Inspection has an ROCE of 5.5%. In absolute terms, that's a low return but it's around the Professional Services industry average of 6.0%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Machinery Huanyu Certification and Inspection's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of China Machinery Huanyu Certification and Inspection.

What Can We Tell From China Machinery Huanyu Certification and Inspection's ROCE Trend?

In terms of China Machinery Huanyu Certification and Inspection's historical ROCE movements, the trend isn't fantastic. Around four years ago the returns on capital were 9.6%, but since then they've fallen to 5.5%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, China Machinery Huanyu Certification and Inspection has done well to pay down its current liabilities to 12% 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

Bringing it all together, while we're somewhat encouraged by China Machinery Huanyu Certification and Inspection's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 7.3% over the last year, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we found 3 warning signs for China Machinery Huanyu Certification and Inspection (1 shouldn't be ignored) you should be aware of.

While China Machinery Huanyu Certification and Inspection 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.