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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Shanxi Huaxiang Group (SHSE:603112) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Shanxi Huaxiang Group:

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

0.076 = CN¥283m ÷ (CN¥5.1b - CN¥1.4b) (Based on the trailing twelve months to September 2022).

Thus, Shanxi Huaxiang Group has an ROCE of 7.6%. In absolute terms, that's a low return but it's around the Machinery industry average of 6.6%.

See our latest analysis for Shanxi Huaxiang Group

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 Shanxi Huaxiang Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Shanxi Huaxiang Group doesn't inspire confidence. To be more specific, ROCE has fallen from 13% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Shanxi Huaxiang Group has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Shanxi Huaxiang Group's ROCE

In summary, Shanxi Huaxiang Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Additionally, the stock's total return to shareholders over the last year has been flat, which isn't too surprising. Therefore based on the analysis done in this article, we don't think Shanxi Huaxiang Group has the makings of a multi-bagger.

If you want to know some of the risks facing Shanxi Huaxiang Group we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.

While Shanxi Huaxiang 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.