To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. So, when we ran our eye over Yifeng Pharmacy Chain's (SHSE:603939) trend of ROCE, we liked what we saw.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Yifeng Pharmacy Chain is:

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

0.14 = CN¥2.1b ÷ (CN¥26b - CN¥11b) (Based on the trailing twelve months to March 2024).

Therefore, Yifeng Pharmacy Chain has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Consumer Retailing industry average of 6.4% it's much better.

In the above chart we have measured Yifeng Pharmacy Chain'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 Yifeng Pharmacy Chain for free.

What The Trend Of ROCE Can Tell Us

While the current returns on capital are decent, they haven't changed much. The company has employed 193% more capital in the last five years, and the returns on that capital have remained stable at 14%. 14% is a pretty standard return, and it provides some comfort knowing that Yifeng Pharmacy Chain has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On a side note, Yifeng Pharmacy Chain's current liabilities are still rather high at 42% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From Yifeng Pharmacy Chain's ROCE

In the end, Yifeng Pharmacy Chain has proven its ability to adequately reinvest capital at good rates of return. However, over the last five years, the stock has only delivered a 5.9% return to shareholders who held over that period. So to determine if Yifeng Pharmacy Chain is a multi-bagger going forward, we'd suggest digging deeper into the company's other fundamentals.

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

While Yifeng Pharmacy Chain 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com