If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Lingyi iTech (Guangdong) (SZSE:002600) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Lingyi iTech (Guangdong) is:

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

0.13 = CN¥3.2b ÷ (CN¥38b - CN¥14b) (Based on the trailing twelve months to September 2023).

Therefore, Lingyi iTech (Guangdong) has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Electronic industry average of 5.1% it's much better.

See our latest analysis for Lingyi iTech (Guangdong)

In the above chart we have measured Lingyi iTech (Guangdong)'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 Lingyi iTech (Guangdong) here for free.

The Trend Of ROCE

We weren't thrilled with the trend because Lingyi iTech (Guangdong)'s ROCE has reduced by 30% over the last five years, while the business employed 115% more capital. That being said, Lingyi iTech (Guangdong) raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Lingyi iTech (Guangdong) probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Lingyi iTech (Guangdong) has decreased its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Lingyi iTech (Guangdong)'s reinvestment in its own business, we're aware that returns are shrinking. Yet to long term shareholders the stock has gifted them an incredible 131% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Lingyi iTech (Guangdong) does come with some risks, and we've found 1 warning sign that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.