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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Shanghai Hugong Electric GroupLtd (SHSE:603131) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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

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. Analysts use this formula to calculate it for Shanghai Hugong Electric GroupLtd:

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

0.011 = CN¥20m ÷ (CN¥2.3b - CN¥526m) (Based on the trailing twelve months to June 2023).

Therefore, Shanghai Hugong Electric GroupLtd has an ROCE of 1.1%. Ultimately, that's a low return and it under-performs the Machinery industry average of 6.4%.

Check out our latest analysis for Shanghai Hugong Electric GroupLtd

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 Shanghai Hugong Electric GroupLtd has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Shanghai Hugong Electric GroupLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 8.0% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for Shanghai Hugong Electric GroupLtd have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 75% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

Shanghai Hugong Electric GroupLtd does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.

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.