What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after investigating Hubei Yihua Chemical Industry (SZSE:000422), we don't think it's current trends fit the mold of a multi-bagger.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Hubei Yihua Chemical Industry, this is the formula:

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

0.05 = CN¥661m ÷ (CN¥22b - CN¥9.2b) (Based on the trailing twelve months to March 2024).

Therefore, Hubei Yihua Chemical Industry has an ROCE of 5.0%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.

Above you can see how the current ROCE for Hubei Yihua Chemical Industry compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Hubei Yihua Chemical Industry for free.

What Can We Tell From Hubei Yihua Chemical Industry's ROCE Trend?

The trend of ROCE doesn't look fantastic because it's fallen from 30% five years ago, while the business's capital employed increased by 167%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Hubei Yihua Chemical Industry might not have received a full period of earnings contribution from it.

On a related note, Hubei Yihua Chemical Industry has decreased its current liabilities to 41% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

In Conclusion...

We're a bit apprehensive about Hubei Yihua Chemical Industry because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 301% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 5 warning signs for Hubei Yihua Chemical Industry (of which 1 is potentially serious!) that you should know about.

While Hubei Yihua Chemical Industry 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