If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at GEM (SZSE:002340) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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 GEM, this is the formula:

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

0.034 = CN¥1.1b ÷ (CN¥62b - CN¥28b) (Based on the trailing twelve months to September 2024).

Thus, GEM has an ROCE of 3.4%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.8%.

In the above chart we have measured GEM's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering GEM for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at GEM doesn't inspire confidence. Around five years ago the returns on capital were 11%, but since then they've fallen to 3.4%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that GEM has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From GEM's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that GEM is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 64% over the last five years, it would appear that investors are upbeat about the future. 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 GEM (at least 2 which don't sit too well with us) , and understanding these would certainly be useful.

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.