If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Changchun FAWAY Automobile ComponentsLtd (SHSE:600742), it didn't seem to tick all of these boxes.

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. To calculate this metric for Changchun FAWAY Automobile ComponentsLtd, this is the formula:

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

0.037 = CN¥411m ÷ (CN¥22b - CN¥11b) (Based on the trailing twelve months to June 2024).

Thus, Changchun FAWAY Automobile ComponentsLtd has an ROCE of 3.7%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 7.2%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Changchun FAWAY Automobile ComponentsLtd.

The Trend Of ROCE

In terms of Changchun FAWAY Automobile ComponentsLtd's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.7% from 5.0% five years ago. 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 side note, Changchun FAWAY Automobile ComponentsLtd's current liabilities have increased over the last five years to 50% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.7%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Changchun FAWAY Automobile ComponentsLtd's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 2.9% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you want to continue researching Changchun FAWAY Automobile ComponentsLtd, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Changchun FAWAY Automobile ComponentsLtd 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.

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.