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. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Shenzhen hongfuhan Technology (SZSE:301086), we don't think it's current trends fit the mold of a multi-bagger.

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

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 Shenzhen hongfuhan Technology is:

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

0.038 = CN¥79m ÷ (CN¥2.5b - CN¥370m) (Based on the trailing twelve months to March 2024).

Thus, Shenzhen hongfuhan Technology has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 5.2%.

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

How Are Returns Trending?

In terms of Shenzhen hongfuhan Technology's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 43% over the last five years. 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'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 side note, Shenzhen hongfuhan Technology has done well to pay down its current liabilities to 15% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Shenzhen hongfuhan Technology's ROCE

To conclude, we've found that Shenzhen hongfuhan Technology is reinvesting in the business, but returns have been falling. And in the last year, the stock has given away 12% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Shenzhen hongfuhan Technology (of which 2 make us uncomfortable!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com