Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think Zhejiang Zhengguang Industrial (SZSE:301092) 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)

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 Zhejiang Zhengguang Industrial, this is the formula:

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

0.046 = CN¥86m ÷ (CN¥2.0b - CN¥167m) (Based on the trailing twelve months to March 2024).

Therefore, Zhejiang Zhengguang Industrial has an ROCE of 4.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Zhengguang Industrial's ROCE against it's prior returns. If you'd like to look at how Zhejiang Zhengguang Industrial has performed in the past in other metrics, you can view this free graph of Zhejiang Zhengguang Industrial's past earnings, revenue and cash flow.

What Does the ROCE Trend For Zhejiang Zhengguang Industrial Tell Us?

In terms of Zhejiang Zhengguang Industrial's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 24%, but since then they've fallen to 4.6%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Zhejiang Zhengguang Industrial has decreased its current liabilities to 8.2% of total assets. So we could link some of this to the decrease in ROCE. 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. 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.

The Bottom Line

We're a bit apprehensive about Zhejiang Zhengguang Industrial because despite more capital being deployed in the business, returns on that capital and sales have both fallen. And long term shareholders have watched their investments stay flat over the last year. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Zhejiang Zhengguang Industrial does have some risks, we noticed 3 warning signs (and 2 which are concerning) we think you should know about.

While Zhejiang Zhengguang Industrial 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.