To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Guangzhou Haozhi IndustrialLtd (SZSE:300503) so let's look a bit deeper.

What Is 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. Analysts use this formula to calculate it for Guangzhou Haozhi IndustrialLtd:

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

0.043 = CN¥74m ÷ (CN¥2.7b - CN¥910m) (Based on the trailing twelve months to September 2024).

So, Guangzhou Haozhi IndustrialLtd has an ROCE of 4.3%. On its own, that's a low figure but it's around the 5.2% average generated by the Machinery industry.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Guangzhou Haozhi IndustrialLtd's ROCE against it's prior returns. If you're interested in investigating Guangzhou Haozhi IndustrialLtd's past further, check out this free graph covering Guangzhou Haozhi IndustrialLtd's past earnings, revenue and cash flow.

How Are Returns Trending?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 4.3%. Basically the business is earning more per dollar of capital invested and in addition to that, 33% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 34% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

To sum it up, Guangzhou Haozhi IndustrialLtd has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with a respectable 81% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. In light of that, we think it's worth looking further into this stock because if Guangzhou Haozhi IndustrialLtd can keep these trends up, it could have a bright future ahead.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Guangzhou Haozhi IndustrialLtd (of which 2 make us uncomfortable!) that you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.