What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Hubei Jiuzhiyang Infrared System (SZSE:300516) so let's look a bit deeper.
Understanding Return On Capital Employed (ROCE)
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 Hubei Jiuzhiyang Infrared System:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = CN¥85m ÷ (CN¥1.7b - CN¥422m) (Based on the trailing twelve months to December 2023).
Thus, Hubei Jiuzhiyang Infrared System has an ROCE of 6.4%. 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.
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 Hubei Jiuzhiyang Infrared System's past further, check out this free graph covering Hubei Jiuzhiyang Infrared System's past earnings, revenue and cash flow.
What Can We Tell From Hubei Jiuzhiyang Infrared System's ROCE Trend?
Hubei Jiuzhiyang Infrared System has not disappointed with their ROCE growth. More specifically, while the company has kept capital employed relatively flat over the last five years, the ROCE has climbed 56% in that same time. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 24% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Bottom Line
To sum it up, Hubei Jiuzhiyang Infrared System is collecting higher returns from the same amount of capital, and that's impressive. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 27% to shareholders. So with that in mind, we think the stock deserves further research.
Like most companies, Hubei Jiuzhiyang Infrared System does come with some risks, and we've found 1 warning sign that you should be aware of.
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.