If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after investigating Cathay Biotech (SHSE:688065), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Cathay Biotech is:

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

0.015 = CN¥237m ÷ (CN¥19b - CN¥2.9b) (Based on the trailing twelve months to September 2023).

Thus, Cathay Biotech has an ROCE of 1.5%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

View our latest analysis for Cathay Biotech

In the above chart we have measured Cathay Biotech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Cathay Biotech.

The Trend Of ROCE

We weren't thrilled with the trend because Cathay Biotech's ROCE has reduced by 91% over the last five years, while the business employed 416% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Cathay Biotech probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a related note, Cathay Biotech has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Cathay Biotech's ROCE

In summary, we're somewhat concerned by Cathay Biotech's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 27% over the last three years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Cathay Biotech could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.

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.