If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating China Nature Energy Technology Holdings (HKG:1597), we don't think it's current trends fit the mold of a multi-bagger.

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 China Nature Energy Technology Holdings is:

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

0.014 = CN¥4.0m ÷ (CN¥504m - CN¥219m) (Based on the trailing twelve months to June 2023).

So, China Nature Energy Technology Holdings has an ROCE of 1.4%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.6%.

View our latest analysis for China Nature Energy Technology Holdings

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

What Does the ROCE Trend For China Nature Energy Technology Holdings Tell Us?

When we looked at the ROCE trend at China Nature Energy Technology Holdings, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 1.4% from 29% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

On a side note, China Nature Energy Technology Holdings has done well to pay down its current liabilities to 43% 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. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for China Nature Energy Technology Holdings have fallen, meanwhile the business is employing more capital than it was five years ago. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 458%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you want to know some of the risks facing China Nature Energy Technology Holdings we've found 2 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.

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.