If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 HONG RI DA Technology (SZSE:301285), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on HONG RI DA Technology is:

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

0.0099 = CN¥11m ÷ (CN¥1.7b - CN¥601m) (Based on the trailing twelve months to September 2023).

Thus, HONG RI DA Technology has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Electronic industry average of 5.1%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for HONG RI DA Technology's ROCE against it's prior returns. If you'd like to look at how HONG RI DA Technology has performed in the past in other metrics, you can view this free graph of HONG RI DA Technology's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at HONG RI DA Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last four years. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, HONG RI DA Technology has done well to pay down its current liabilities to 35% 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

Bringing it all together, while we're somewhat encouraged by HONG RI DA Technology's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 30% over the last year, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Like most companies, HONG RI DA Technology does come with some risks, and we've found 2 warning signs that you should be aware of.

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.