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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Shanxi Huhua Group's (SZSE:003002) returns on capital, so let's have a look.
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. The formula for this calculation on Shanxi Huhua Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = CN¥217m ÷ (CN¥1.9b - CN¥394m) (Based on the trailing twelve months to September 2023).
Therefore, Shanxi Huhua Group has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.6% it's much better.
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 want to delve into the historical earnings, revenue and cash flow of Shanxi Huhua Group, check out these free graphs here.
So How Is Shanxi Huhua Group's ROCE Trending?
The trends we've noticed at Shanxi Huhua Group are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 14%. 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 160%. So we're very much inspired by what we're seeing at Shanxi Huhua Group thanks to its ability to profitably reinvest capital.
The Bottom Line On Shanxi Huhua Group's ROCE
To sum it up, Shanxi Huhua Group has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 19% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
One more thing to note, we've identified 1 warning sign with Shanxi Huhua Group and understanding it should be part of your investment process.
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.