If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Anhui Quanchai Engine (SHSE:600218), it didn't seem to tick all of these boxes.

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 Anhui Quanchai Engine, this is the formula:

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

0.016 = CN¥54m ÷ (CN¥6.3b - CN¥3.0b) (Based on the trailing twelve months to March 2022).

Therefore, Anhui Quanchai Engine has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 7.4%.

See our latest analysis for Anhui Quanchai Engine

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Anhui Quanchai Engine's past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

We weren't thrilled with the trend because Anhui Quanchai Engine's ROCE has reduced by 65% over the last five years, while the business employed 66% more capital. Usually this isn't ideal, but given Anhui Quanchai Engine conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Anhui Quanchai Engine's earnings and if they change as a result from the capital raise.

On a separate but related note, it's important to know that Anhui Quanchai Engine has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. 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.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Anhui Quanchai Engine. In light of this, the stock has only gained 19% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing to note, we've identified 5 warning signs with Anhui Quanchai Engine and understanding them should be part of your investment process.

While Anhui Quanchai Engine 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.