Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So when we looked at the ROCE trend of Shanghai Baosight SoftwareLtd (SHSE:600845) we really liked what we saw.

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. To calculate this metric for Shanghai Baosight SoftwareLtd, this is the formula:

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

0.21 = CN¥2.6b ÷ (CN¥21b - CN¥9.2b) (Based on the trailing twelve months to September 2023).

Therefore, Shanghai Baosight SoftwareLtd has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 2.7% earned by companies in a similar industry.

In the above chart we have measured Shanghai Baosight SoftwareLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Baosight SoftwareLtd for free.

What Can We Tell From Shanghai Baosight SoftwareLtd's ROCE Trend?

The trends we've noticed at Shanghai Baosight SoftwareLtd are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 21%. Basically the business is earning more per dollar of capital invested and in addition to that, 83% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 43% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

The Bottom Line On Shanghai Baosight SoftwareLtd's ROCE

In summary, it's great to see that Shanghai Baosight SoftwareLtd can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 270% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Shanghai Baosight SoftwareLtd can keep these trends up, it could have a bright future ahead.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for 600845 that compares the share price and estimated value.

Shanghai Baosight SoftwareLtd is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.