If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Although, when we looked at Xiamen East Asia Machinery Industrial (SZSE:301028), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Xiamen East Asia Machinery Industrial:

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

0.11 = CN¥141m ÷ (CN¥1.8b - CN¥489m) (Based on the trailing twelve months to September 2023).

Thus, Xiamen East Asia Machinery Industrial has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 6.1% generated by the Machinery industry.

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

What Can We Tell From Xiamen East Asia Machinery Industrial's ROCE Trend?

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 11% from 20% four years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Xiamen East Asia Machinery Industrial has decreased its current liabilities to 28% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Xiamen East Asia Machinery Industrial's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Xiamen East Asia Machinery Industrial is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 25% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Like most companies, Xiamen East Asia Machinery Industrial does come with some risks, and we've found 1 warning sign that you should be aware of.

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.