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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Lens Technology (SZSE:300433) and its ROCE trend, we weren't exactly thrilled.
What Is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Lens Technology:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.066 = CN¥3.9b ÷ (CN¥75b - CN¥17b) (Based on the trailing twelve months to September 2023).
Thus, Lens Technology has an ROCE of 6.6%. On its own that's a low return, but compared to the average of 5.3% generated by the Electronic industry, it's much better.
In the above chart we have measured Lens Technology'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 Lens Technology .
How Are Returns Trending?
In terms of Lens Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 14% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, Lens Technology has decreased its current liabilities to 22% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Lens Technology is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 36% gain to shareholders who've held over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.
Lens Technology does have some risks though, and we've spotted 1 warning sign for Lens Technology that you might be interested in.
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.