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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So when we looked at Shanghai Kinlita Chemical (SZSE:300225) and its trend of ROCE, we really liked what we saw.

What Is 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. Analysts use this formula to calculate it for Shanghai Kinlita Chemical:

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

0.027 = CN¥23m ÷ (CN¥1.3b - CN¥421m) (Based on the trailing twelve months to March 2024).

So, Shanghai Kinlita Chemical has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 5.5%.

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

So How Is Shanghai Kinlita Chemical's ROCE Trending?

Shanghai Kinlita Chemical has broken into the black (profitability) and we're sure it's a sight for sore eyes. While the business was unprofitable in the past, it's now turned things around and is earning 2.7% on its capital. While returns have increased, the amount of capital employed by Shanghai Kinlita Chemical has remained flat over the period. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. Because in the end, a business can only get so efficient.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 33% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

What We Can Learn From Shanghai Kinlita Chemical's ROCE

As discussed above, Shanghai Kinlita Chemical appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 6.9% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One final note, you should learn about the 3 warning signs we've spotted with Shanghai Kinlita Chemical (including 1 which can't be ignored) .

While Shanghai Kinlita Chemical 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com