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. With that in mind, the ROCE of New Hope Dairy (SZSE:002946) looks decent, right now, so lets see what the trend of returns can tell us.

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

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for New Hope Dairy:

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

0.12 = CN¥665m ÷ (CN¥9.3b - CN¥3.8b) (Based on the trailing twelve months to September 2023).

Thus, New Hope Dairy has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 7.6% generated by the Food industry.

In the above chart we have measured New Hope Dairy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for New Hope Dairy .

What Can We Tell From New Hope Dairy's ROCE Trend?

While the returns on capital are good, they haven't moved much. The company has consistently earned 12% for the last five years, and the capital employed within the business has risen 166% in that time. 12% is a pretty standard return, and it provides some comfort knowing that New Hope Dairy has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 41% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously. We'd like to see this trend continue though because as it stands today, thats still a pretty high level.

Our Take On New Hope Dairy's ROCE

The main thing to remember is that New Hope Dairy has proven its ability to continually reinvest at respectable rates of return. However, despite the favorable fundamentals, the stock has fallen 47% over the last five years, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.

One more thing, we've spotted 2 warning signs facing New Hope Dairy that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.