To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Xiamen East Asia Machinery Industrial (SZSE:301028), it didn't seem to tick all of these boxes.

What Is 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. To calculate this metric for Xiamen East Asia Machinery Industrial, this is the formula:

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

0.12 = CN¥149m ÷ (CN¥1.7b - CN¥465m) (Based on the trailing twelve months to June 2023).

So, Xiamen East Asia Machinery Industrial has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 6.9% generated by the Machinery industry.

View our latest analysis for Xiamen East Asia Machinery Industrial

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Xiamen East Asia Machinery Industrial's past further, check out this free graph of past earnings, revenue and cash flow.

So How Is Xiamen East Asia Machinery Industrial's ROCE Trending?

When we looked at the ROCE trend at Xiamen East Asia Machinery Industrial, we didn't gain much confidence. Over the last four years, returns on capital have decreased to 12% from 21% four years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Xiamen East Asia Machinery Industrial has done well to pay down its current liabilities to 27% 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.

The Bottom Line

In summary, Xiamen East Asia Machinery Industrial is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And with the stock having returned a mere 6.9% in the last year to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Xiamen East Asia Machinery Industrial, we've discovered 1 warning sign that 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.