There are a few key trends to look for if we want to identify the next multi-bagger. 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. So on that note, Shanghai Zhongyida (SHSE:900906) looks quite promising in regards to its trends of return on capital.

Understanding 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 Shanghai Zhongyida is:

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

0.11 = CN¥105m ÷ (CN¥1.2b - CN¥246m) (Based on the trailing twelve months to September 2022).

Thus, Shanghai Zhongyida has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 8.9% it's much better.

Check out our latest analysis for Shanghai Zhongyida

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Zhongyida's ROCE against it's prior returns. If you'd like to look at how Shanghai Zhongyida has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

What Can We Tell From Shanghai Zhongyida's ROCE Trend?

Shanghai Zhongyida has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 77%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 31% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 21%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

The Key Takeaway

From what we've seen above, Shanghai Zhongyida has managed to increase it's returns on capital all the while reducing it's capital base. And with a respectable 77% 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. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you'd like to know more about Shanghai Zhongyida, we've spotted 3 warning signs, and 1 of them makes us a bit uncomfortable.

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.