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. Having said that, from a first glance at Guangdong Guanghua Sci-Tech (SZSE:002741) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. The formula for this calculation on Guangdong Guanghua Sci-Tech is:

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

0.054 = CN¥92m ÷ (CN¥3.0b - CN¥1.3b) (Based on the trailing twelve months to March 2022).

So, Guangdong Guanghua Sci-Tech has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.9%.

See our latest analysis for Guangdong Guanghua Sci-Tech

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'd like to look at how Guangdong Guanghua Sci-Tech has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 8.5% five years ago, while the business's capital employed increased by 102%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Guangdong Guanghua Sci-Tech probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 44%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.4%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Bottom Line On Guangdong Guanghua Sci-Tech's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Guangdong Guanghua Sci-Tech. These trends are starting to be recognized by investors since the stock has delivered a 15% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One final note, you should learn about the 3 warning signs we've spotted with Guangdong Guanghua Sci-Tech (including 1 which makes us a bit uncomfortable) .

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.