If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Although, when we looked at Shenzhen XFH TechnologyLtd (SZSE:300890), it didn't seem to tick all of these boxes.

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

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. To calculate this metric for Shenzhen XFH TechnologyLtd, this is the formula:

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

0.072 = CN¥167m ÷ (CN¥3.9b - CN¥1.6b) (Based on the trailing twelve months to September 2023).

So, Shenzhen XFH TechnologyLtd has an ROCE of 7.2%. In absolute terms, that's a low return but it's around the Electrical industry average of 6.4%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen XFH TechnologyLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shenzhen XFH TechnologyLtd.

What Does the ROCE Trend For Shenzhen XFH TechnologyLtd Tell Us?

On the surface, the trend of ROCE at Shenzhen XFH TechnologyLtd doesn't inspire confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 7.2%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a separate but related note, it's important to know that Shenzhen XFH TechnologyLtd has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Shenzhen XFH TechnologyLtd's ROCE

Bringing it all together, while we're somewhat encouraged by Shenzhen XFH TechnologyLtd's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 28% over the last three years, investors may not be too optimistic on this trend improving either. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Shenzhen XFH TechnologyLtd does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

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.