Returns On Capital At Xiamen Leading Optics (SHSE:605118) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Xiamen Leading Optics (SHSE:605118) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Xiamen Leading Optics is:

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

0.096 = CN¥143m ÷ (CN¥1.7b - CN¥241m) (Based on the trailing twelve months to September 2024).

So, Xiamen Leading Optics has an ROCE of 9.6%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.5%.

Check out our latest analysis for Xiamen Leading Optics

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 Xiamen Leading Optics' past further, check out this free graph covering Xiamen Leading Optics' past earnings, revenue and cash flow.

So How Is Xiamen Leading Optics' ROCE Trending?

When we looked at the ROCE trend at Xiamen Leading Optics, we didn't gain much confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 9.6%. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Xiamen Leading Optics' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 32% over the last three years, investors must think there's better things to come. 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 Xiamen Leading Optics we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.

While Xiamen Leading Optics 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.