What trends should we look for it we want to identify stocks that can 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. 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 IAT Automobile Technology (SZSE:300825), we don't think it's current trends fit the mold of a multi-bagger.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for IAT Automobile Technology:

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

0.014 = CN¥39m ÷ (CN¥3.3b - CN¥444m) (Based on the trailing twelve months to September 2023).

So, IAT Automobile Technology has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Auto industry average of 3.0%.

Check out our latest analysis for IAT Automobile Technology

In the above chart we have measured IAT Automobile Technology'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 IAT Automobile Technology here for free.

So How Is IAT Automobile Technology's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 7.6% five years ago, while the business's capital employed increased by 162%. Usually this isn't ideal, but given IAT Automobile Technology conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence IAT Automobile Technology might not have received a full period of earnings contribution from it.

On a side note, IAT Automobile Technology has done well to pay down its current liabilities to 14% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Bottom Line

In summary, we're somewhat concerned by IAT Automobile Technology's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 29% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you want to continue researching IAT Automobile Technology, you might be interested to know about the 2 warning signs that our analysis has discovered.

While IAT Automobile Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.