To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Lihuayi Weiyuan Chemical (SHSE:600955), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Lihuayi Weiyuan Chemical:

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

0.017 = CN¥173m ÷ (CN¥12b - CN¥1.7b) (Based on the trailing twelve months to September 2023).

So, Lihuayi Weiyuan Chemical has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 5.5%.

View our latest analysis for Lihuayi Weiyuan Chemical

In the above chart we have measured Lihuayi Weiyuan Chemical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Lihuayi Weiyuan Chemical.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Lihuayi Weiyuan Chemical doesn't inspire confidence. To be more specific, ROCE has fallen from 22% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Lihuayi Weiyuan Chemical has done well to pay down its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Lihuayi Weiyuan Chemical's ROCE

We're a bit apprehensive about Lihuayi Weiyuan Chemical because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 16% over the last year, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Lihuayi Weiyuan Chemical (of which 1 is significant!) that you should know about.

While Lihuayi Weiyuan Chemical isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.