To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Hangzhou Zhengqiang (SZSE:301119) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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 Hangzhou Zhengqiang is:

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

0.088 = CN¥83m ÷ (CN¥1.2b - CN¥227m) (Based on the trailing twelve months to September 2023).

Thus, Hangzhou Zhengqiang has an ROCE of 8.8%. In absolute terms, that's a low return, but it's much better than the Auto Components industry average of 6.6%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hangzhou Zhengqiang's ROCE against it's prior returns. If you're interested in investigating Hangzhou Zhengqiang's past further, check out this free graph covering Hangzhou Zhengqiang's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Hangzhou Zhengqiang, we didn't gain much confidence. Around five years ago the returns on capital were 20%, but since then they've fallen to 8.8%. 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.

What We Can Learn From Hangzhou Zhengqiang's ROCE

In summary, Hangzhou Zhengqiang is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 24% in the last year. 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.

Hangzhou Zhengqiang does have some risks, we noticed 2 warning signs (and 1 which is a bit concerning) we think you should know about.

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.