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'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Xiamen Xiangyu (SHSE:600057) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper 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. Analysts use this formula to calculate it for Xiamen Xiangyu:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = CN¥3.1b ÷ (CN¥127b - CN¥82b) (Based on the trailing twelve months to September 2023).
So, Xiamen Xiangyu has an ROCE of 6.9%. Even though it's in line with the industry average of 6.8%, it's still a low return by itself.
Above you can see how the current ROCE for Xiamen Xiangyu compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Xiamen Xiangyu .
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Xiamen Xiangyu, we didn't gain much confidence. To be more specific, ROCE has fallen from 8.8% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Xiamen Xiangyu's current liabilities are still rather high at 65% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From Xiamen Xiangyu's ROCE
In summary, Xiamen Xiangyu is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 75% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
If you want to continue researching Xiamen Xiangyu, you might be interested to know about the 3 warning signs that our analysis has discovered.
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.