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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Suzhou Hesheng Special Material (SZSE:002290) looks quite promising in regards to its trends of return on capital.

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. Analysts use this formula to calculate it for Suzhou Hesheng Special Material:

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

0.12 = CN¥109m ÷ (CN¥1.8b - CN¥915m) (Based on the trailing twelve months to September 2023).

Therefore, Suzhou Hesheng Special Material has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 6.2% it's much better.

See our latest analysis for Suzhou Hesheng Special Material

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

What The Trend Of ROCE Can Tell Us

Suzhou Hesheng Special Material has not disappointed in regards to ROCE growth. The figures show that over the last five years, returns on capital have grown by 52%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 31% less capital than it was five years ago. Suzhou Hesheng Special Material may be selling some assets so it's worth investigating if the business has plans for future investments to increase returns further still.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 50%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see. However, current liabilities are still at a pretty high level, so just be aware that this can bring with it some risks.

The Key Takeaway

In summary, it's great to see that Suzhou Hesheng Special Material has been able to turn things around and earn higher returns on lower amounts of capital. Since the stock has returned a solid 59% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.

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.