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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Ouhua Energy Holdings (SGX:AJ2), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding 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. To calculate this metric for Ouhua Energy Holdings, this is the formula:

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

0.27 = CN¥70m ÷ (CN¥740m - CN¥483m) (Based on the trailing twelve months to June 2022).

So, Ouhua Energy Holdings has an ROCE of 27%. While that is an outstanding return, the rest of the Oil and Gas industry generates similar returns, on average.

View our latest analysis for Ouhua Energy Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Ouhua Energy Holdings' ROCE against it's prior returns. If you're interested in investigating Ouhua Energy Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Ouhua Energy Holdings Tell Us?

On the surface, the trend of ROCE at Ouhua Energy Holdings doesn't inspire confidence. Historically returns on capital were even higher at 43%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Ouhua Energy Holdings has decreased its current liabilities to 65% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 65% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From Ouhua Energy Holdings' 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 Ouhua Energy Holdings. In light of this, the stock has only gained 26% 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.

If you want to know some of the risks facing Ouhua Energy Holdings we've found 4 warning signs (2 are a bit concerning!) that you should be aware of before investing here.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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