To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Wuxi Huaguang Environment & Energy GroupLtd (SHSE:600475), it didn't seem to tick all of these boxes.

What Is 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 Wuxi Huaguang Environment & Energy GroupLtd is:

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

0.052 = CN¥826m ÷ (CN¥25b - CN¥9.2b) (Based on the trailing twelve months to June 2023).

Therefore, Wuxi Huaguang Environment & Energy GroupLtd has an ROCE of 5.2%. In absolute terms, that's a low return but it's around the Machinery industry average of 6.4%.

View our latest analysis for Wuxi Huaguang Environment & Energy GroupLtd

In the above chart we have measured Wuxi Huaguang Environment & Energy GroupLtd'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 Wuxi Huaguang Environment & Energy GroupLtd here for free.

What Can We Tell From Wuxi Huaguang Environment & Energy GroupLtd's ROCE Trend?

The returns on capital haven't changed much for Wuxi Huaguang Environment & Energy GroupLtd in recent years. The company has consistently earned 5.2% for the last five years, and the capital employed within the business has risen 199% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 37% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Bottom Line

Long story short, while Wuxi Huaguang Environment & Energy GroupLtd has been reinvesting its capital, the returns that it's generating haven't increased. Yet to long term shareholders the stock has gifted them an incredible 120% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing: We've identified 2 warning signs with Wuxi Huaguang Environment & Energy GroupLtd (at least 1 which makes us a bit uncomfortable) , and understanding them would certainly be useful.

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.