If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Speaking of which, we noticed some great changes in Guizhou Zhenhua E-chem's (SHSE:688707) returns on capital, so let's have a look.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Guizhou Zhenhua E-chem is:

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

0.098 = CN¥490m ÷ (CN¥8.7b - CN¥3.7b) (Based on the trailing twelve months to September 2023).

Thus, Guizhou Zhenhua E-chem has an ROCE of 9.8%. On its own that's a low return, but compared to the average of 6.3% generated by the Electrical industry, it's much better.

Check out our latest analysis for Guizhou Zhenhua E-chem

In the above chart we have measured Guizhou Zhenhua E-chem's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Guizhou Zhenhua E-chem.

How Are Returns Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The data shows that returns on capital have increased substantially over the last five years to 9.8%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 182%. So we're very much inspired by what we're seeing at Guizhou Zhenhua E-chem thanks to its ability to profitably reinvest capital.

Another thing to note, Guizhou Zhenhua E-chem has a high ratio of current liabilities to total assets of 43%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Guizhou Zhenhua E-chem's ROCE

In summary, it's great to see that Guizhou Zhenhua E-chem can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Given the stock has declined 66% in the last year, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

On a separate note, we've found 3 warning signs for Guizhou Zhenhua E-chem you'll probably want to know about.

While Guizhou Zhenhua E-chem 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.

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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.