If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Dnake (Xiamen) Intelligent Technology (SZSE:300884) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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 Dnake (Xiamen) Intelligent Technology is:

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

0.042 = CN¥58m ÷ (CN¥1.9b - CN¥502m) (Based on the trailing twelve months to September 2023).

Thus, Dnake (Xiamen) Intelligent Technology has an ROCE of 4.2%. On its own, that's a low figure but it's around the 5.1% average generated by the Communications industry.

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 Dnake (Xiamen) Intelligent Technology's past further, check out this free graph covering Dnake (Xiamen) Intelligent Technology's past earnings, revenue and cash flow.

The Trend Of ROCE

On the surface, the trend of ROCE at Dnake (Xiamen) Intelligent Technology doesn't inspire confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 4.2%. However it looks like Dnake (Xiamen) Intelligent Technology 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, Dnake (Xiamen) Intelligent Technology 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. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 On Dnake (Xiamen) Intelligent Technology's ROCE

Bringing it all together, while we're somewhat encouraged by Dnake (Xiamen) Intelligent Technology's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 45% in the last three years. Therefore based on the analysis done in this article, we don't think Dnake (Xiamen) Intelligent Technology has the makings of a multi-bagger.

Dnake (Xiamen) Intelligent Technology does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are significant...

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.