Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Zibuyu Group (HKG:2420) and its ROCE trend, we weren't exactly thrilled.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Zibuyu Group, this is the formula:

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

0.11 = CN¥90m ÷ (CN¥1.3b - CN¥530m) (Based on the trailing twelve months to June 2023).

Therefore, Zibuyu Group has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 9.9% generated by the Specialty Retail industry.

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'd like to look at how Zibuyu Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Zibuyu Group's ROCE Trending?

On the surface, the trend of ROCE at Zibuyu Group doesn't inspire confidence. Over the last one year, returns on capital have decreased to 11% from 44% one year ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Zibuyu Group has done well to pay down its current liabilities to 40% 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, despite lower returns in the short term, we're encouraged to see that Zibuyu Group is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 22% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Zibuyu Group does have some risks though, and we've spotted 2 warning signs for Zibuyu Group that you might be interested in.

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.