If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. Having said that, from a first glance at Shanghai Chlor-Alkali Chemical (SHSE:600618) 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)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Shanghai Chlor-Alkali Chemical:

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

0.069 = CN¥667m ÷ (CN¥12b - CN¥2.3b) (Based on the trailing twelve months to June 2023).

So, Shanghai Chlor-Alkali Chemical has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.9%.

View our latest analysis for Shanghai Chlor-Alkali Chemical

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Chlor-Alkali Chemical's ROCE against it's prior returns. If you're interested in investigating Shanghai Chlor-Alkali Chemical's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Shanghai Chlor-Alkali Chemical's ROCE Trend?

In terms of Shanghai Chlor-Alkali Chemical's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 26% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Shanghai Chlor-Alkali Chemical has decreased its current liabilities to 19% 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.

In Conclusion...

We're a bit apprehensive about Shanghai Chlor-Alkali Chemical because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these concerning fundamentals, the stock has performed strongly with a 49% return over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know about the risks facing Shanghai Chlor-Alkali Chemical, we've discovered 2 warning signs that you should be aware of.

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.