Xiamen Leading Optics (SHSE:605118) Will Want To Turn Around Its Return Trends

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. 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 Xiamen Leading Optics (SHSE:605118), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Xiamen Leading Optics:

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

0.092 = CN¥141m ÷ (CN¥1.7b - CN¥120m) (Based on the trailing twelve months to March 2024).

Therefore, Xiamen Leading Optics has an ROCE of 9.2%. On its own that's a low return, but compared to the average of 5.2% generated by the Electronic industry, it's much better.

View our latest analysis for Xiamen Leading Optics

Historical performance is a great place to start when researching a stock so above you can see the gauge for Xiamen Leading Optics' ROCE against it's prior returns. If you'd like to look at how Xiamen Leading Optics has performed in the past in other metrics, you can view this free graph of Xiamen Leading Optics' past earnings, revenue and cash flow.

So How Is Xiamen Leading Optics' ROCE Trending?

On the surface, the trend of ROCE at Xiamen Leading Optics doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.2% from 42% five years ago. However it looks like Xiamen Leading Optics might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Xiamen Leading Optics has decreased its current liabilities to 7.2% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line On Xiamen Leading Optics' ROCE

To conclude, we've found that Xiamen Leading Optics is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 8.7% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Xiamen Leading Optics does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...

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.