If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Although, when we looked at Zhongji Innolight (SZSE:300308), it didn't seem to tick all of these boxes.

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. To calculate this metric for Zhongji Innolight, this is the formula:

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

0.11 = CN¥1.6b ÷ (CN¥19b - CN¥3.7b) (Based on the trailing twelve months to September 2023).

Thus, Zhongji Innolight has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 5.1% generated by the Communications industry.

See our latest analysis for Zhongji Innolight

In the above chart we have measured Zhongji Innolight's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

When we looked at the ROCE trend at Zhongji Innolight, we didn't gain much confidence. To be more specific, ROCE has fallen from 15% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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 related note, Zhongji Innolight has decreased its current liabilities to 19% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 Key Takeaway

In summary, Zhongji Innolight is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 259% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you want to continue researching Zhongji Innolight, you might be interested to know about the 1 warning sign that our analysis has discovered.

While Zhongji Innolight 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.