There are a few key trends to look for if we want to identify the next 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at Zhonghong Pulin Medical Products (SZSE:300981) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Zhonghong Pulin Medical Products, this is the formula:

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

0.0014 = CN¥8.6m ÷ (CN¥7.6b - CN¥1.5b) (Based on the trailing twelve months to March 2024).

Thus, Zhonghong Pulin Medical Products has an ROCE of 0.1%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 7.2%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhonghong Pulin Medical Products' 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 Zhonghong Pulin Medical Products.

What Does the ROCE Trend For Zhonghong Pulin Medical Products Tell Us?

On the surface, the trend of ROCE at Zhonghong Pulin Medical Products doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 0.1%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Zhonghong Pulin Medical Products has decreased its current liabilities to 20% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

In Conclusion...

While returns have fallen for Zhonghong Pulin Medical Products in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. But since the stock has dived 78% in the last three years, there could be other drivers that are influencing the business' outlook. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.

One more thing to note, we've identified 2 warning signs with Zhonghong Pulin Medical Products and understanding them should be part of your investment process.

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.