If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Essence Fastening Systems (Shanghai) (SZSE:301005), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Essence Fastening Systems (Shanghai), this is the formula:

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

0.0038 = CN¥3.1m ÷ (CN¥1.2b - CN¥371m) (Based on the trailing twelve months to September 2024).

Therefore, Essence Fastening Systems (Shanghai) has an ROCE of 0.4%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 7.0%.

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 Essence Fastening Systems (Shanghai).

What Can We Tell From Essence Fastening Systems (Shanghai)'s ROCE Trend?

When we looked at the ROCE trend at Essence Fastening Systems (Shanghai), we didn't gain much confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 0.4%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Essence Fastening Systems (Shanghai)'s ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Essence Fastening Systems (Shanghai). And the stock has followed suit returning a meaningful 42% to shareholders over the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One more thing: We've identified 3 warning signs with Essence Fastening Systems (Shanghai) (at least 1 which is a bit concerning) , and understanding them would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.