If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at Shenzhen hongfuhan Technology (SZSE:301086) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for Shenzhen hongfuhan Technology, this is the formula:

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

0.063 = CN¥127m ÷ (CN¥2.5b - CN¥438m) (Based on the trailing twelve months to September 2023).

So, Shenzhen hongfuhan Technology has an ROCE of 6.3%. In absolute terms, that's a low return, but it's much better than the Electronic industry average of 5.0%.

See our latest analysis for Shenzhen hongfuhan Technology

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

What Can We Tell From Shenzhen hongfuhan Technology's ROCE Trend?

When we looked at the ROCE trend at Shenzhen hongfuhan Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 48% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Shenzhen hongfuhan Technology has done well to pay down its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Shenzhen hongfuhan Technology's ROCE

To conclude, we've found that Shenzhen hongfuhan Technology is reinvesting in the business, but returns have been falling. Since the stock has declined 13% over the last year, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing: We've identified 2 warning signs with Shenzhen hongfuhan Technology (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Shenzhen hongfuhan Technology 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.