If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Guangdong Nedfon Air System (SZSE:301043) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Guangdong Nedfon Air System, this is the formula:

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

0.089 = CN¥75m ÷ (CN¥1.1b - CN¥238m) (Based on the trailing twelve months to September 2023).

So, Guangdong Nedfon Air System has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 6.4% generated by the Building industry, it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangdong Nedfon Air System's ROCE against it's prior returns. If you'd like to look at how Guangdong Nedfon Air System has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Guangdong Nedfon Air System's ROCE Trend?

On the surface, the trend of ROCE at Guangdong Nedfon Air System doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.9% from 36% five years ago. However it looks like Guangdong Nedfon Air System might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Guangdong Nedfon Air System has done well to pay down its current liabilities to 22% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

To conclude, we've found that Guangdong Nedfon Air System is reinvesting in the business, but returns have been falling. Additionally, the stock's total return to shareholders over the last year has been flat, which isn't too surprising. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing: We've identified 2 warning signs with Guangdong Nedfon Air System (at least 1 which can't be ignored) , and understanding them would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.