Did you know there are some financial metrics that can provide clues of a potential multi-bagger? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Shanxi Meijin EnergyLtd (SZSE:000723), 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. Analysts use this formula to calculate it for Shanxi Meijin EnergyLtd:

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

0.069 = CN¥1.7b ÷ (CN¥40b - CN¥16b) (Based on the trailing twelve months to September 2023).

Therefore, Shanxi Meijin EnergyLtd has an ROCE of 6.9%. Even though it's in line with the industry average of 6.9%, it's still a low return by itself.

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're interested in investigating Shanxi Meijin EnergyLtd's past further, check out this free graph covering Shanxi Meijin EnergyLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Shanxi Meijin EnergyLtd doesn't inspire confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 6.9%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, Shanxi Meijin EnergyLtd has decreased its current liabilities to 40% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Shanxi Meijin EnergyLtd's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Shanxi Meijin EnergyLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last five years have experienced a 60% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Shanxi Meijin EnergyLtd, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.

While Shanxi Meijin EnergyLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.