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. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Longyan Kaolin Clay (SHSE:605086) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Longyan Kaolin Clay is:

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

0.10 = CN¥123m ÷ (CN¥1.3b - CN¥82m) (Based on the trailing twelve months to September 2024).

So, Longyan Kaolin Clay has an ROCE of 10%. On its own, that's a standard return, however it's much better than the 5.9% generated by the Basic Materials industry.

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 Longyan Kaolin Clay has performed in the past in other metrics, you can view this free graph of Longyan Kaolin Clay's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

In terms of Longyan Kaolin Clay's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 10% from 21% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Longyan Kaolin Clay has decreased its current liabilities to 6.3% 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 Longyan Kaolin Clay's ROCE

While returns have fallen for Longyan Kaolin Clay in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 86% to shareholders over the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Longyan Kaolin Clay does have some risks though, and we've spotted 1 warning sign for Longyan Kaolin Clay that you might be interested in.

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.