To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, we've noticed some promising trends at China Literature (HKG:772) so let's look a bit deeper.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on China Literature is:

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

0.039 = CN¥760m ÷ (CN¥24b - CN¥4.9b) (Based on the trailing twelve months to June 2024).

Therefore, China Literature has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Media industry average of 8.0%.

In the above chart we have measured China Literature'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 China Literature for free.

What Can We Tell From China Literature's ROCE Trend?

While there are companies with higher returns on capital out there, we still find the trend at China Literature promising. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 86% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

What We Can Learn From China Literature's ROCE

To sum it up, China Literature is collecting higher returns from the same amount of capital, and that's impressive. Astute investors may have an opportunity here because the stock has declined 27% in the last five years. So researching this company further and determining whether or not these trends will continue seems justified.

On a separate note, we've found 1 warning sign for China Literature you'll probably want to know about.

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.