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. With that in mind, the ROCE of China Tobacco International (HK) (HKG:6055) looks great, so lets see what the trend can tell us.

What Is 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. The formula for this calculation on China Tobacco International (HK) is:

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

0.36 = HK$1.2b ÷ (HK$9.7b - HK$6.5b) (Based on the trailing twelve months to June 2024).

Therefore, China Tobacco International (HK) has an ROCE of 36%. In absolute terms that's a great return and it's even better than the Retail Distributors industry average of 14%.

View our latest analysis for China Tobacco International (HK)

In the above chart we have measured China Tobacco International (HK)'s prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering China Tobacco International (HK) for free.

What The Trend Of ROCE Can Tell Us

China Tobacco International (HK) is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 36%. Basically the business is earning more per dollar of capital invested and in addition to that, 146% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 67% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what China Tobacco International (HK) has. Since the stock has only returned 34% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

If you want to continue researching China Tobacco International (HK), you might be interested to know about the 1 warning sign that our analysis has discovered.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.