Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Shanghai Action Education TechnologyLTD (SHSE:605098) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Shanghai Action Education TechnologyLTD is:

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

0.18 = CN¥171m ÷ (CN¥1.9b - CN¥981m) (Based on the trailing twelve months to September 2023).

Therefore, Shanghai Action Education TechnologyLTD has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Consumer Services industry average of 6.5% it's much better.

Above you can see how the current ROCE for Shanghai Action Education TechnologyLTD compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shanghai Action Education TechnologyLTD here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Shanghai Action Education TechnologyLTD doesn't inspire confidence. To be more specific, ROCE has fallen from 39% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Shanghai Action Education TechnologyLTD has decreased its current liabilities to 51% 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. Keep in mind 51% is still pretty high, so those risks are still somewhat prevalent.

Our Take On Shanghai Action Education TechnologyLTD's ROCE

In summary, Shanghai Action Education TechnologyLTD is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 11% over the last year. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 1 warning sign with Shanghai Action Education TechnologyLTD and understanding it should be part of your investment process.

While Shanghai Action Education TechnologyLTD 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.