To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Guangzhou Tongda Auto Electric (SHSE:603390) 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 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. To calculate this metric for Guangzhou Tongda Auto Electric, this is the formula:

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

0.0083 = CN¥13m ÷ (CN¥1.8b - CN¥183m) (Based on the trailing twelve months to June 2024).

Thus, Guangzhou Tongda Auto Electric has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 7.4%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangzhou Tongda Auto Electric's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Guangzhou Tongda Auto Electric.

How Are Returns Trending?

In terms of Guangzhou Tongda Auto Electric's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 0.8%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 related note, Guangzhou Tongda Auto Electric has decreased its current liabilities to 10% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

What We Can Learn From Guangzhou Tongda Auto Electric's ROCE

Bringing it all together, while we're somewhat encouraged by Guangzhou Tongda Auto Electric's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 15% over the last three years, investors may not be too optimistic on this trend improving either. 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.

On a final note, we've found 2 warning signs for Guangzhou Tongda Auto Electric that we think you should be aware of.

While Guangzhou Tongda Auto Electric 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.