To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Guangdong Sanhe Pile (SZSE:003037) and its ROCE trend, we weren't exactly thrilled.

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 Guangdong Sanhe Pile, this is the formula:

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

0.05 = CN¥182m ÷ (CN¥6.8b - CN¥3.2b) (Based on the trailing twelve months to September 2023).

Therefore, Guangdong Sanhe Pile has an ROCE of 5.0%. In absolute terms, that's a low return but it's around the Basic Materials industry average of 6.1%.

See our latest analysis for Guangdong Sanhe Pile

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Guangdong Sanhe Pile has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 29% five years ago, while capital employed has grown 264%. Usually this isn't ideal, but given Guangdong Sanhe Pile conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Guangdong Sanhe Pile's earnings and if they change as a result from the capital raise.

On a related note, Guangdong Sanhe Pile has decreased its current liabilities to 47% of total assets. So we could link some of this to the decrease in ROCE. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Guangdong Sanhe Pile's ROCE

Bringing it all together, while we're somewhat encouraged by Guangdong Sanhe Pile's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 11% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

On a final note, we found 4 warning signs for Guangdong Sanhe Pile (1 is a bit concerning) you should be aware of.

While Guangdong Sanhe Pile 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.