There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at ValueHD (SZSE:301318), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on ValueHD is:

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

0.02 = CN¥36m ÷ (CN¥1.9b - CN¥120m) (Based on the trailing twelve months to June 2024).

So, ValueHD has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Communications industry average of 4.4%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how ValueHD has performed in the past in other metrics, you can view this free graph of ValueHD's past earnings, revenue and cash flow.

What Can We Tell From ValueHD's ROCE Trend?

On the surface, the trend of ROCE at ValueHD doesn't inspire confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 2.0%. However it looks like ValueHD 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, ValueHD has decreased its current liabilities to 6.2% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From ValueHD's ROCE

Bringing it all together, while we're somewhat encouraged by ValueHD's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 32% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 1 warning sign for ValueHD that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.