To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in XDC Industries (Shenzhen)'s (SZSE:300615) returns on capital, so let's have a look.

Understanding 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. Analysts use this formula to calculate it for XDC Industries (Shenzhen):

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

0.22 = CN¥126m ÷ (CN¥816m - CN¥238m) (Based on the trailing twelve months to September 2023).

Thus, XDC Industries (Shenzhen) has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 5.2% earned by companies in a similar 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're interested in investigating XDC Industries (Shenzhen)'s past further, check out this free graph covering XDC Industries (Shenzhen)'s past earnings, revenue and cash flow.

What Can We Tell From XDC Industries (Shenzhen)'s ROCE Trend?

The trends we've noticed at XDC Industries (Shenzhen) are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 22%. Basically the business is earning more per dollar of capital invested and in addition to that, 25% more capital is being employed now too. So we're very much inspired by what we're seeing at XDC Industries (Shenzhen) thanks to its ability to profitably reinvest capital.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 29% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

To sum it up, XDC Industries (Shenzhen) has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Given the stock has declined 23% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

If you want to continue researching XDC Industries (Shenzhen), you might be interested to know about the 2 warning signs that our analysis has discovered.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.