Did you know there are some financial metrics that can provide clues of a potential 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. That's why when we briefly looked at Shanghai Huafon Aluminium's (SHSE:601702) ROCE trend, we were very happy with what we saw.
Understanding 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 Shanghai Huafon Aluminium, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = CN¥910m ÷ (CN¥6.9b - CN¥2.4b) (Based on the trailing twelve months to September 2023).
Therefore, Shanghai Huafon Aluminium has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 6.2%.
See our latest analysis for Shanghai Huafon Aluminium
In the above chart we have measured Shanghai Huafon Aluminium's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
Shanghai Huafon Aluminium deserves to be commended in regards to it's returns. The company has consistently earned 20% for the last five years, and the capital employed within the business has risen 188% in that time. Now considering ROCE is an attractive 20%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 35% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
What We Can Learn From Shanghai Huafon Aluminium's ROCE
In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And the stock has done incredibly well with a 102% return over the last three years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you'd like to know about the risks facing Shanghai Huafon Aluminium, we've discovered 1 warning sign that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.