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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Shanghai Chicmax Cosmetic (HKG:2145), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Shanghai Chicmax Cosmetic, this is the formula:

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

0.054 = CN¥98m ÷ (CN¥2.8b - CN¥1.0b) (Based on the trailing twelve months to June 2023).

So, Shanghai Chicmax Cosmetic has an ROCE of 5.4%. Ultimately, that's a low return and it under-performs the Personal Products industry average of 10%.

See our latest analysis for Shanghai Chicmax Cosmetic

In the above chart we have measured Shanghai Chicmax Cosmetic's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Shanghai Chicmax Cosmetic's ROCE Trend?

On the surface, the trend of ROCE at Shanghai Chicmax Cosmetic doesn't inspire confidence. Over the last three years, returns on capital have decreased to 5.4% from 26% three years ago. However it looks like Shanghai Chicmax Cosmetic 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 side note, Shanghai Chicmax Cosmetic has done well to pay down 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.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Shanghai Chicmax Cosmetic's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 17% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

Shanghai Chicmax Cosmetic could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

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.