Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating FriendLtd (SHSE:605050), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for FriendLtd, this is the formula:

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

0.12 = CN¥516m ÷ (CN¥6.7b - CN¥2.5b) (Based on the trailing twelve months to September 2023).

Therefore, FriendLtd has an ROCE of 12%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 6.2% it's much better.

View our latest analysis for FriendLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating FriendLtd's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is FriendLtd's ROCE Trending?

Unfortunately, the trend isn't great with ROCE falling from 24% five years ago, while capital employed has grown 181%. 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. It's unlikely that all of the funds raised have been put to work yet, so as a consequence FriendLtd might not have received a full period of earnings contribution from it.

On a related note, FriendLtd has decreased its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 FriendLtd's ROCE

Bringing it all together, while we're somewhat encouraged by FriendLtd's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 15% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing: We've identified 3 warning signs with FriendLtd (at least 1 which shouldn't be ignored) , and understanding them would certainly be useful.

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.