If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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 Cathay Biotech (SHSE:688065) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for Cathay Biotech:

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

0.013 = CN¥202m ÷ (CN¥19b - CN¥2.8b) (Based on the trailing twelve months to March 2024).

Therefore, Cathay Biotech has an ROCE of 1.3%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Cathay Biotech's ROCE against it's prior returns. If you're interested in investigating Cathay Biotech's past further, check out this free graph covering Cathay Biotech's past earnings, revenue and cash flow.

What Can We Tell From Cathay Biotech's ROCE Trend?

On the surface, the trend of ROCE at Cathay Biotech doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.3% from 14% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Cathay Biotech has decreased its current liabilities to 15% 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.

In Conclusion...

To conclude, we've found that Cathay Biotech is reinvesting in the business, but returns have been falling. Since the stock has declined 23% 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.

On a final note, we've found 1 warning sign for Cathay Biotech that we think you should be aware of.

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.