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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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. However, after briefly looking over the numbers, we don't think Shang Gong Group (SHSE:600843) 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)

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. The formula for this calculation on Shang Gong Group is:

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

0.0024 = CN¥9.7m ÷ (CN¥6.6b - CN¥2.5b) (Based on the trailing twelve months to September 2024).

Therefore, Shang Gong Group has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.2%.

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 want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shang Gong Group.

How Are Returns Trending?

On the surface, the trend of ROCE at Shang Gong Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.2% from 3.2% 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 side note, Shang Gong Group's current liabilities have increased over the last five years to 38% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Shang Gong Group is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 100% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a separate note, we've found 2 warning signs for Shang Gong Group you'll probably want to know about.

While Shang Gong Group 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.