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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at EGing Photovoltaic TechnologyLtd (SHSE:600537) and its trend of ROCE, we really liked what we saw.

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 EGing Photovoltaic TechnologyLtd, this is the formula:

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

0.11 = CN¥514m ÷ (CN¥13b - CN¥7.9b) (Based on the trailing twelve months to September 2023).

So, EGing Photovoltaic TechnologyLtd has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Semiconductor industry average of 4.2% it's much better.

Check out our latest analysis for EGing Photovoltaic TechnologyLtd

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 EGing Photovoltaic TechnologyLtd 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?

EGing Photovoltaic TechnologyLtd has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 11% on its capital, because five years ago it was incurring losses. While returns have increased, the amount of capital employed by EGing Photovoltaic TechnologyLtd has remained flat over the period. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 63% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From EGing Photovoltaic TechnologyLtd's ROCE

As discussed above, EGing Photovoltaic TechnologyLtd appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 78% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you'd like to know about the risks facing EGing Photovoltaic TechnologyLtd, we've discovered 1 warning sign that you should be aware of.

While EGing Photovoltaic TechnologyLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.