What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. That's why when we briefly looked at Shanghai Huafon Aluminium's (SHSE:601702) ROCE trend, we were very happy with what we saw.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Shanghai Huafon Aluminium:

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

0.22 = CN¥1.1b ÷ (CN¥7.4b - CN¥2.4b) (Based on the trailing twelve months to March 2024).

So, Shanghai Huafon Aluminium has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 6.7% earned by companies in a similar industry.

Above you can see how the current ROCE for Shanghai Huafon Aluminium compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shanghai Huafon Aluminium for free.

The Trend Of ROCE

It's hard not to be impressed by Shanghai Huafon Aluminium's returns on capital. The company has employed 231% more capital in the last five years, and the returns on that capital have remained stable at 22%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 33% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

In Conclusion...

In summary, we're delighted to see that Shanghai Huafon Aluminium has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 160% return to those who've held over the last three years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 1 warning sign with Shanghai Huafon Aluminium and understanding it should be part of your investment process.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.