Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. However, after briefly looking over the numbers, we don't think Shang Gong Group (SHSE:600843) 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 Shang Gong Group:

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

0.026 = CN¥111m ÷ (CN¥6.5b - CN¥2.3b) (Based on the trailing twelve months to March 2024).

Therefore, Shang Gong Group has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.9%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shang Gong Group's ROCE against it's prior returns. If you'd like to look at how Shang Gong Group has performed in the past in other metrics, you can view this free graph of Shang Gong Group's past earnings, revenue and cash flow.

The Trend Of ROCE

When we looked at the ROCE trend at Shang Gong Group, we didn't gain much confidence. Around five years ago the returns on capital were 5.6%, but since then they've fallen to 2.6%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Shang Gong Group is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 4.7% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

On a final note, we found 3 warning signs for Shang Gong Group (2 make us uncomfortable) you should be aware of.

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.