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. With that in mind, we've noticed some promising trends at First Tractor (HKG:38) so let's look a bit deeper.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on First Tractor is:

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

0.092 = CN¥714m ÷ (CN¥14b - CN¥6.0b) (Based on the trailing twelve months to December 2023).

So, First Tractor has an ROCE of 9.2%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.1%.

Above you can see how the current ROCE for First Tractor compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering First Tractor for free.

What Does the ROCE Trend For First Tractor Tell Us?

First Tractor has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 9.2% on its capital. And unsurprisingly, like most companies trying to break into the black, First Tractor is utilizing 30% more capital than it was five years ago. 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 44%, 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. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.

What We Can Learn From First Tractor's ROCE

Long story short, we're delighted to see that First Tractor's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 312% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if First Tractor can keep these trends up, it could have a bright future ahead.

One more thing to note, we've identified 1 warning sign with First Tractor and understanding it should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.