What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after investigating Guangdong No.2 Hydropower Engineering Company (SZSE:002060), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for Guangdong No.2 Hydropower Engineering Company:

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

0.032 = CN¥1.1b ÷ (CN¥117b - CN¥82b) (Based on the trailing twelve months to September 2023).

So, Guangdong No.2 Hydropower Engineering Company has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Construction industry average of 6.8%.

View our latest analysis for Guangdong No.2 Hydropower Engineering Company

In the above chart we have measured Guangdong No.2 Hydropower Engineering Company'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 Guangdong No.2 Hydropower Engineering Company here for free.

So How Is Guangdong No.2 Hydropower Engineering Company's ROCE Trending?

In terms of Guangdong No.2 Hydropower Engineering Company's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 6.4% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. 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 side note, Guangdong No.2 Hydropower Engineering Company's current liabilities have increased over the last five years to 70% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 3.2%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

The Key Takeaway

We're a bit apprehensive about Guangdong No.2 Hydropower Engineering Company 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 94% 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.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Guangdong No.2 Hydropower Engineering Company (of which 3 shouldn't be ignored!) that you should know about.

While Guangdong No.2 Hydropower Engineering Company 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.