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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Shanghai Chlor-Alkali Chemical (SHSE:600618) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Shanghai Chlor-Alkali Chemical:

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

0.068 = CN¥671m ÷ (CN¥12b - CN¥2.3b) (Based on the trailing twelve months to September 2023).

Therefore, Shanghai Chlor-Alkali Chemical has an ROCE of 6.8%. In absolute terms, that's a low return but it's around the Chemicals industry average of 6.1%.

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'd like to look at how Shanghai Chlor-Alkali Chemical has performed in the past in other metrics, you can view this free graph of Shanghai Chlor-Alkali Chemical's past earnings, revenue and cash flow.

So How Is Shanghai Chlor-Alkali Chemical's ROCE Trending?

On the surface, the trend of ROCE at Shanghai Chlor-Alkali Chemical doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. However it looks like Shanghai Chlor-Alkali Chemical 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 related note, Shanghai Chlor-Alkali Chemical has decreased its current liabilities to 19% 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Shanghai Chlor-Alkali Chemical's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 12% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing, we've spotted 2 warning signs facing Shanghai Chlor-Alkali Chemical that you might find interesting.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.