There are a few key trends to look for if we want to identify the next 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Hangzhou Lion ElectronicsLtd (SHSE:605358), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Hangzhou Lion ElectronicsLtd is:

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

0.01 = CN¥167m ÷ (CN¥18b - CN¥2.0b) (Based on the trailing twelve months to September 2023).

So, Hangzhou Lion ElectronicsLtd has an ROCE of 1.0%. Ultimately, that's a low return and it under-performs the Semiconductor industry average of 5.3%.

Above you can see how the current ROCE for Hangzhou Lion ElectronicsLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Hangzhou Lion ElectronicsLtd for free.

How Are Returns Trending?

In terms of Hangzhou Lion ElectronicsLtd's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 9.4% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hangzhou Lion ElectronicsLtd has done well to pay down its current liabilities to 11% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 On Hangzhou Lion ElectronicsLtd's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Hangzhou Lion ElectronicsLtd have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 63% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Hangzhou Lion ElectronicsLtd does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit unpleasant...

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.