If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at Guangdong Fangyuan New Materials Group (SHSE:688148) and its ROCE trend, we weren't exactly thrilled.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Guangdong Fangyuan New Materials Group, this is the formula:

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

0.016 = CN¥30m ÷ (CN¥3.6b - CN¥1.6b) (Based on the trailing twelve months to June 2022).

Thus, Guangdong Fangyuan New Materials Group has an ROCE of 1.6%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 9.7%.

Check out our latest analysis for Guangdong Fangyuan New Materials Group

In the above chart we have measured Guangdong Fangyuan New Materials Group'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 Guangdong Fangyuan New Materials Group here for free.

The Trend Of ROCE

When we looked at the ROCE trend at Guangdong Fangyuan New Materials Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 2.5% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Guangdong Fangyuan New Materials Group's current liabilities have increased over the last five years to 46% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 1.6%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On Guangdong Fangyuan New Materials Group'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 Fangyuan New Materials Group. And there could be an opportunity here if other metrics look good too, because the stock has declined 38% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

If you'd like to know more about Guangdong Fangyuan New Materials Group, we've spotted 4 warning signs, and 3 of them make us uncomfortable.

While Guangdong Fangyuan New Materials Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.