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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Huadong Medicine (SZSE:000963) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Huadong Medicine, this is the formula:

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

0.15 = CN¥3.6b ÷ (CN¥34b - CN¥11b) (Based on the trailing twelve months to March 2024).

Thus, Huadong Medicine has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 9.5% generated by the Healthcare industry.

In the above chart we have measured Huadong Medicine'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 Huadong Medicine for free.

What Does the ROCE Trend For Huadong Medicine Tell Us?

When we looked at the ROCE trend at Huadong Medicine, we didn't gain much confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 15%. 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.

What We Can Learn From Huadong Medicine's ROCE

To conclude, we've found that Huadong Medicine is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 10% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing, we've spotted 1 warning sign facing Huadong Medicine that you might find interesting.

While Huadong Medicine may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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