To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. However, after investigating Guangdong Hongxing Industrial (SZSE:001209), we don't think it's current trends fit the mold of a multi-bagger.

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 Guangdong Hongxing Industrial is:

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

0.031 = CN¥39m ÷ (CN¥1.5b - CN¥204m) (Based on the trailing twelve months to September 2022).

Thus, Guangdong Hongxing Industrial has an ROCE of 3.1%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 5.1%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Guangdong Hongxing Industrial's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Guangdong Hongxing Industrial's ROCE Trending?

On the surface, the trend of ROCE at Guangdong Hongxing Industrial doesn't inspire confidence. Over the last four years, returns on capital have decreased to 3.1% from 34% four years ago. However it looks like Guangdong Hongxing Industrial 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'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, Guangdong Hongxing Industrial has done well to pay down its current liabilities to 14% 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.

Our Take On Guangdong Hongxing Industrial's ROCE

To conclude, we've found that Guangdong Hongxing Industrial is reinvesting in the business, but returns have been falling. Additionally, the stock's total return to shareholders over the last year has been flat, which isn't too surprising. 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.

On a final note, we found 4 warning signs for Guangdong Hongxing Industrial (2 make us uncomfortable) you should be aware of.

While Guangdong Hongxing Industrial 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.