What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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 investigating Shanxi Lanhua Sci-Tech VentureLtd (SHSE:600123), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shanxi Lanhua Sci-Tech VentureLtd, this is the formula:

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

0.074 = CN¥1.6b ÷ (CN¥31b - CN¥9.3b) (Based on the trailing twelve months to September 2024).

Therefore, Shanxi Lanhua Sci-Tech VentureLtd has an ROCE of 7.4%. Ultimately, that's a low return and it under-performs the Oil and Gas industry average of 10.0%.

In the above chart we have measured Shanxi Lanhua Sci-Tech VentureLtd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanxi Lanhua Sci-Tech VentureLtd for free.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shanxi Lanhua Sci-Tech VentureLtd, we didn't gain much confidence. Around five years ago the returns on capital were 9.7%, but since then they've fallen to 7.4%. However it looks like Shanxi Lanhua Sci-Tech VentureLtd 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 side note, Shanxi Lanhua Sci-Tech VentureLtd has done well to pay down its current liabilities to 30% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Shanxi Lanhua Sci-Tech VentureLtd's ROCE

In summary, Shanxi Lanhua Sci-Tech VentureLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 122% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

If you'd like to know more about Shanxi Lanhua Sci-Tech VentureLtd, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.