To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Shandong Linglong TyreLtd (SHSE:601966) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Shandong Linglong TyreLtd, this is the formula:

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

0.045 = CN¥1.1b ÷ (CN¥42b - CN¥18b) (Based on the trailing twelve months to September 2023).

Thus, Shandong Linglong TyreLtd has an ROCE of 4.5%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 5.8%.

View our latest analysis for Shandong Linglong TyreLtd

Above you can see how the current ROCE for Shandong Linglong TyreLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shandong Linglong TyreLtd here for free.

So How Is Shandong Linglong TyreLtd's ROCE Trending?

On the surface, the trend of ROCE at Shandong Linglong TyreLtd doesn't inspire confidence. Around five years ago the returns on capital were 12%, but since then they've fallen to 4.5%. 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. 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 Shandong Linglong TyreLtd has a current liabilities to total assets ratio of 42%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Shandong Linglong TyreLtd's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Shandong Linglong TyreLtd is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 50% 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.

While Shandong Linglong TyreLtd doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Shandong Linglong TyreLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.