Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Wolong Electric GroupLtd (SHSE:600580) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for Wolong Electric GroupLtd, this is the formula:

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

0.075 = CN¥1.1b ÷ (CN¥26b - CN¥11b) (Based on the trailing twelve months to June 2024).

Therefore, Wolong Electric GroupLtd has an ROCE of 7.5%. In absolute terms, that's a low return, but it's much better than the Electrical industry average of 6.1%.

Above you can see how the current ROCE for Wolong Electric GroupLtd 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 Wolong Electric GroupLtd for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Wolong Electric GroupLtd, we didn't gain much confidence. Around five years ago the returns on capital were 9.8%, but since then they've fallen to 7.5%. However it looks like Wolong Electric GroupLtd might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that Wolong Electric GroupLtd has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Wolong Electric GroupLtd's ROCE

To conclude, we've found that Wolong Electric GroupLtd is reinvesting in the business, but returns have been falling. And investors may be recognizing these trends since the stock has only returned a total of 23% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing to note, we've identified 3 warning signs with Wolong Electric GroupLtd and understanding them should be part of your investment process.

While Wolong Electric GroupLtd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.