If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 briefly looking over the numbers, we don't think Shanghai Hollywave Electronic System (SHSE:688682) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Shanghai Hollywave Electronic System:

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

0.055 = CN¥39m ÷ (CN¥970m - CN¥270m) (Based on the trailing twelve months to September 2023).

So, Shanghai Hollywave Electronic System has an ROCE of 5.5%. On its own that's a low return, but compared to the average of 2.7% generated by the Software industry, it's much better.

Check out our latest analysis for Shanghai Hollywave Electronic System

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

So How Is Shanghai Hollywave Electronic System's ROCE Trending?

In terms of Shanghai Hollywave Electronic System's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 40% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Shanghai Hollywave Electronic System has done well to pay down its current liabilities to 28% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Shanghai Hollywave Electronic System's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 25% over the last year, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you want to know some of the risks facing Shanghai Hollywave Electronic System we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

While Shanghai Hollywave Electronic System may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.