If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at China Petroleum Engineering (SHSE:600339) so let's look a bit deeper.

Return On Capital Employed (ROCE): What Is It?

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 China Petroleum Engineering is:

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

0.065 = CN¥2.0b ÷ (CN¥106b - CN¥76b) (Based on the trailing twelve months to September 2023).

Thus, China Petroleum Engineering has an ROCE of 6.5%. On its own, that's a low figure but it's around the 7.1% average generated by the Energy Services industry.

See our latest analysis for China Petroleum Engineering

In the above chart we have measured China Petroleum Engineering'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 China Petroleum Engineering here for free.

So How Is China Petroleum Engineering's ROCE Trending?

While in absolute terms it isn't a high ROCE, it's promising to see that it has been moving in the right direction. The data shows that returns on capital have increased substantially over the last five years to 6.5%. The amount of capital employed has increased too, by 23%. So we're very much inspired by what we're seeing at China Petroleum Engineering thanks to its ability to profitably reinvest capital.

On a separate but related note, it's important to know that China Petroleum Engineering has a current liabilities to total assets ratio of 71%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, it's great to see that China Petroleum Engineering can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Astute investors may have an opportunity here because the stock has declined 26% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, China Petroleum Engineering does come with some risks, and we've found 2 warning signs 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.