If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Hunan Sokan New Materials (SHSE:688157), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Hunan Sokan New Materials, this is the formula:

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

0.067 = CN¥88m ÷ (CN¥1.5b - CN¥175m) (Based on the trailing twelve months to December 2023).

Therefore, Hunan Sokan New Materials has an ROCE of 6.7%. On its own, that's a low figure but it's around the 6.0% average generated by the Chemicals industry.

In the above chart we have measured Hunan Sokan New Materials' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hunan Sokan New Materials .

So How Is Hunan Sokan New Materials' ROCE Trending?

On the surface, the trend of ROCE at Hunan Sokan New Materials doesn't inspire confidence. To be more specific, ROCE has fallen from 15% over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Hunan Sokan New Materials has decreased its current liabilities to 12% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Hunan Sokan New Materials' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Hunan Sokan New Materials is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 47% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Hunan Sokan New Materials does come with some risks, and we've found 1 warning sign that you should be aware of.

While Hunan Sokan New Materials isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.