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. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Ningbo Yongxin OpticsLtd (SHSE:603297), it didn't seem to tick all of these boxes.

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

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 Ningbo Yongxin OpticsLtd is:

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

0.081 = CN¥138m ÷ (CN¥1.9b - CN¥211m) (Based on the trailing twelve months to June 2023).

So, Ningbo Yongxin OpticsLtd has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 5.4% generated by the Electronic industry, it's much better.

In the above chart we have measured Ningbo Yongxin OpticsLtd'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 analyst report for Ningbo Yongxin OpticsLtd .

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 13% five years ago, while the business's capital employed increased by 105%. Usually this isn't ideal, but given Ningbo Yongxin OpticsLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Ningbo Yongxin OpticsLtd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

What We Can Learn From Ningbo Yongxin OpticsLtd's ROCE

To conclude, we've found that Ningbo Yongxin OpticsLtd is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 106% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to know some of the risks facing Ningbo Yongxin OpticsLtd we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.

While Ningbo Yongxin OpticsLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.