To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Shenzhen Deren Electronic (SZSE:002055) so let's look a bit deeper.

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

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 Shenzhen Deren Electronic, this is the formula:

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

0.019 = CN¥80m ÷ (CN¥7.7b - CN¥3.4b) (Based on the trailing twelve months to March 2024).

Thus, Shenzhen Deren Electronic has an ROCE of 1.9%. Ultimately, that's a low return and it under-performs the Electronic industry average of 5.4%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Deren Electronic's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shenzhen Deren Electronic.

What Can We Tell From Shenzhen Deren Electronic's ROCE Trend?

While there are companies with higher returns on capital out there, we still find the trend at Shenzhen Deren Electronic promising. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 60% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.

On a related note, the company's ratio of current liabilities to total assets has decreased to 44%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.

What We Can Learn From Shenzhen Deren Electronic's ROCE

To bring it all together, Shenzhen Deren Electronic has done well to increase the returns it's generating from its capital employed. And since the stock has fallen 45% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Shenzhen Deren Electronic (of which 2 are potentially serious!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.