What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Zhejiang Hongchang Electrical Technology (SZSE:301008), it didn't seem to tick all of these boxes.

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

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Zhejiang Hongchang Electrical Technology:

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

0.043 = CN¥63m ÷ (CN¥1.9b - CN¥447m) (Based on the trailing twelve months to September 2023).

Thus, Zhejiang Hongchang Electrical Technology has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 6.5%.

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Zhejiang Hongchang Electrical Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 4.3% from 17% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Zhejiang Hongchang Electrical Technology has done well to pay down its current liabilities to 24% 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. 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 On Zhejiang Hongchang Electrical Technology's ROCE

Bringing it all together, while we're somewhat encouraged by Zhejiang Hongchang Electrical Technology's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 11% over the last year. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to continue researching Zhejiang Hongchang Electrical Technology, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Zhejiang Hongchang Electrical Technology isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.