If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 briefly looking over the numbers, we don't think Zhejiang Lianxiang Smart Home (SHSE:603272) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Zhejiang Lianxiang Smart Home is:

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

0.016 = CN¥10.0m ÷ (CN¥714m - CN¥74m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Lianxiang Smart Home has an ROCE of 1.6%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 7.9%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhejiang Lianxiang Smart Home's ROCE against it's prior returns. If you're interested in investigating Zhejiang Lianxiang Smart Home's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Zhejiang Lianxiang Smart Home's ROCE Trend?

On the surface, the trend of ROCE at Zhejiang Lianxiang Smart Home doesn't inspire confidence. Around four years ago the returns on capital were 46%, but since then they've fallen to 1.6%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Lianxiang Smart Home has done well to pay down its current liabilities to 10% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

We're a bit apprehensive about Zhejiang Lianxiang Smart Home because despite more capital being deployed in the business, returns on that capital and sales have both fallen. It should come as no surprise then that the stock has fallen 32% over the last year, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Zhejiang Lianxiang Smart Home does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.

While Zhejiang Lianxiang Smart Home 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.