If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Shenzhen Changhong Technology (SZSE:300151) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Changhong Technology, this is the formula:

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

0.017 = CN¥39m ÷ (CN¥2.5b - CN¥240m) (Based on the trailing twelve months to September 2023).

Thus, Shenzhen Changhong Technology has an ROCE of 1.7%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.0%.

Above you can see how the current ROCE for Shenzhen Changhong Technology 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 Shenzhen Changhong Technology for free.

So How Is Shenzhen Changhong Technology's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 5.3% five years ago, while the business's capital employed increased by 161%. That being said, Shenzhen Changhong Technology raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Shenzhen Changhong Technology probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Shenzhen Changhong Technology's reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 130% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Shenzhen Changhong Technology (of which 1 makes us a bit uncomfortable!) that you should know about.

While Shenzhen Changhong 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.