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'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at Hwaxin EnvironmentalLtd (SZSE:301265), it didn't seem to tick all of these boxes.

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 Hwaxin EnvironmentalLtd:

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

0.042 = CN¥91m ÷ (CN¥2.3b - CN¥77m) (Based on the trailing twelve months to September 2023).

Thus, Hwaxin EnvironmentalLtd has an ROCE of 4.2%. Ultimately, that's a low return and it under-performs the Commercial Services 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 Hwaxin EnvironmentalLtd's ROCE against it's prior returns. If you'd like to look at how Hwaxin EnvironmentalLtd has performed in the past in other metrics, you can view this free graph of Hwaxin EnvironmentalLtd's past earnings, revenue and cash flow.

The Trend Of ROCE

In terms of Hwaxin EnvironmentalLtd's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 11% over the last five years. However it looks like Hwaxin EnvironmentalLtd might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Hwaxin EnvironmentalLtd has decreased its current liabilities to 3.4% 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.

Our Take On Hwaxin EnvironmentalLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Hwaxin EnvironmentalLtd's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 22% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Hwaxin EnvironmentalLtd (of which 1 is a bit unpleasant!) that you should know about.

While Hwaxin EnvironmentalLtd 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.