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. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Qingdao Zhongzi Zhongcheng GroupLtd (SZSE:300208), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Qingdao Zhongzi Zhongcheng GroupLtd, this is the formula:

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

0.18 = CN¥215m ÷ (CN¥4.7b - CN¥3.5b) (Based on the trailing twelve months to June 2023).

Thus, Qingdao Zhongzi Zhongcheng GroupLtd has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Electrical industry average of 6.3% it's much better.

Check out our latest analysis for Qingdao Zhongzi Zhongcheng GroupLtd

Historical performance is a great place to start when researching a stock so above you can see the gauge for Qingdao Zhongzi Zhongcheng GroupLtd's ROCE against it's prior returns. If you'd like to look at how Qingdao Zhongzi Zhongcheng 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?

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 45% in that same period. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. So if this trend continues, don't be surprised if the business is smaller in a few years time.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 74% of total assets, this reported ROCE would probably be less than18% because total capital employed would be higher.The 18% ROCE could be even lower if current liabilities weren't 74% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

In Conclusion...

Overall, we're not ecstatic to see Qingdao Zhongzi Zhongcheng GroupLtd reducing the amount of capital it employs in the business. Unsurprisingly, the stock has only gained 30% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing to note, we've identified 2 warning signs with Qingdao Zhongzi Zhongcheng GroupLtd and understanding them should be part of your investment process.

While Qingdao Zhongzi Zhongcheng GroupLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.