What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Hangzhou EZVIZ Network (SHSE:688475), we don't think it's current trends fit the mold of a multi-bagger.

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

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. The formula for this calculation on Hangzhou EZVIZ Network is:

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

0.076 = CN¥424m ÷ (CN¥7.7b - CN¥2.1b) (Based on the trailing twelve months to September 2023).

Therefore, Hangzhou EZVIZ Network has an ROCE of 7.6%. On its own that's a low return, but compared to the average of 5.0% generated by the Electronic industry, it's much better.

Check out our latest analysis for Hangzhou EZVIZ Network

Above you can see how the current ROCE for Hangzhou EZVIZ Network 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 Hangzhou EZVIZ Network here for free.

What Does the ROCE Trend For Hangzhou EZVIZ Network Tell Us?

When we looked at the ROCE trend at Hangzhou EZVIZ Network, we didn't gain much confidence. Around four years ago the returns on capital were 28%, but since then they've fallen to 7.6%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Hangzhou EZVIZ Network has done well to pay down its current liabilities to 27% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Hangzhou EZVIZ Network's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 74% over the last year. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Hangzhou EZVIZ Network does have some risks, we noticed 2 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

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.