If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. In light of that, when we looked at Nine Dragons Paper (Holdings) (HKG:2689) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Nine Dragons Paper (Holdings):

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

0.0037 = CN¥366m ÷ (CN¥129b - CN¥30b) (Based on the trailing twelve months to December 2023).

Therefore, Nine Dragons Paper (Holdings) has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Forestry industry average of 7.7%.

Above you can see how the current ROCE for Nine Dragons Paper (Holdings) 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 Nine Dragons Paper (Holdings) for free.

So How Is Nine Dragons Paper (Holdings)'s ROCE Trending?

In terms of Nine Dragons Paper (Holdings)'s historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 0.4%. However it looks like Nine Dragons Paper (Holdings) might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Nine Dragons Paper (Holdings)'s reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing to note, we've identified 1 warning sign with Nine Dragons Paper (Holdings) and understanding this should be part of your investment process.

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.

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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.

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