There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Espressif Systems (Shanghai) (SHSE:688018) looks quite promising in regards to its trends of return on capital.

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 Espressif Systems (Shanghai) is:

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

0.11 = CN¥237m ÷ (CN¥2.5b - CN¥324m) (Based on the trailing twelve months to September 2024).

So, Espressif Systems (Shanghai) has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 4.8% generated by the Semiconductor industry.

In the above chart we have measured Espressif Systems (Shanghai)'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 Espressif Systems (Shanghai) for free.

How Are Returns Trending?

The trends we've noticed at Espressif Systems (Shanghai) are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 11%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 37%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

What We Can Learn From Espressif Systems (Shanghai)'s ROCE

All in all, it's terrific to see that Espressif Systems (Shanghai) is reaping the rewards from prior investments and is growing its capital base. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 31% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

Like most companies, Espressif Systems (Shanghai) does come with some risks, and we've found 1 warning sign that you should be aware of.

While Espressif Systems (Shanghai) 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.