What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Haier Smart Home's (SHSE:600690) ROCE trend, we were pretty happy with what we saw.

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

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 Haier Smart Home, this is the formula:

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

0.14 = CN¥14b ÷ (CN¥227b - CN¥128b) (Based on the trailing twelve months to June 2022).

So, Haier Smart Home has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 9.8% generated by the Consumer Durables industry.

Check out our latest analysis for Haier Smart Home

In the above chart we have measured Haier Smart Home's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Haier Smart Home here for free.

What The Trend Of ROCE Can Tell Us

While the current returns on capital are decent, they haven't changed much. The company has consistently earned 14% for the last five years, and the capital employed within the business has risen 49% in that time. 14% is a pretty standard return, and it provides some comfort knowing that Haier Smart Home has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On a separate but related note, it's important to know that Haier Smart Home has a current liabilities to total assets ratio of 56%, 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.

What We Can Learn From Haier Smart Home's ROCE

In the end, Haier Smart Home has proven its ability to adequately reinvest capital at good rates of return. And long term investors would be thrilled with the 106% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One more thing: We've identified 2 warning signs with Haier Smart Home (at least 1 which is a bit concerning) , and understanding them would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.