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. However, after briefly looking over the numbers, we don't think Zhejiang Sanfer Electric (SHSE:605336) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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 Zhejiang Sanfer Electric:

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

0.083 = CN¥162m ÷ (CN¥2.2b - CN¥282m) (Based on the trailing twelve months to September 2023).

Therefore, Zhejiang Sanfer Electric has an ROCE of 8.3%. Even though it's in line with the industry average of 8.1%, it's still a low return by itself.

In the above chart we have measured Zhejiang Sanfer Electric'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 Zhejiang Sanfer Electric for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Zhejiang Sanfer Electric doesn't inspire confidence. Around five years ago the returns on capital were 35%, but since then they've fallen to 8.3%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Zhejiang Sanfer Electric has done well to pay down its current liabilities to 13% 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.

What We Can Learn From Zhejiang Sanfer Electric's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for Zhejiang Sanfer Electric have fallen, meanwhile the business is employing more capital than it was five years ago. Long term shareholders who've owned the stock over the last three years have experienced a 28% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

On a separate note, we've found 1 warning sign for Zhejiang Sanfer Electric you'll probably want to know about.

While Zhejiang Sanfer Electric isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.