There are a few key trends to look for if we want to identify the next multi-bagger. 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. However, after briefly looking over the numbers, we don't think Hengdian Group Tospo Lighting (SHSE:603303) 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. To calculate this metric for Hengdian Group Tospo Lighting, this is the formula:

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

0.082 = CN¥301m ÷ (CN¥6.6b - CN¥3.0b) (Based on the trailing twelve months to March 2024).

Thus, Hengdian Group Tospo Lighting has an ROCE of 8.2%. On its own that's a low return, but compared to the average of 6.0% generated by the Electrical industry, it's much better.

Above you can see how the current ROCE for Hengdian Group Tospo Lighting 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 Hengdian Group Tospo Lighting for free.

What Does the ROCE Trend For Hengdian Group Tospo Lighting Tell Us?

There are better returns on capital out there than what we're seeing at Hengdian Group Tospo Lighting. The company has employed 41% more capital in the last five years, and the returns on that capital have remained stable at 8.2%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 45% of total assets, this reported ROCE would probably be less than8.2% because total capital employed would be higher.The 8.2% ROCE could be even lower if current liabilities weren't 45% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

Our Take On Hengdian Group Tospo Lighting's ROCE

Long story short, while Hengdian Group Tospo Lighting has been reinvesting its capital, the returns that it's generating haven't increased. Since the stock has gained an impressive 48% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Hengdian Group Tospo Lighting does come with some risks, and we've found 2 warning signs that you should be aware of.

While Hengdian Group Tospo Lighting 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.