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. 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 Henan Liliang Diamond (SZSE:301071), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Henan Liliang Diamond is:

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

0.058 = CN¥334m ÷ (CN¥6.6b - CN¥851m) (Based on the trailing twelve months to September 2023).

Thus, Henan Liliang Diamond has an ROCE of 5.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

See our latest analysis for Henan Liliang Diamond

In the above chart we have measured Henan Liliang Diamond's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Henan Liliang Diamond.

So How Is Henan Liliang Diamond's ROCE Trending?

In terms of Henan Liliang Diamond's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 21%, but since then they've fallen to 5.8%. 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 may take some time before the company starts to see any change in earnings from these investments.

On a related note, Henan Liliang Diamond has decreased its current liabilities to 13% of total assets. That could partly explain why the ROCE has dropped. 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.

What We Can Learn From Henan Liliang Diamond's ROCE

In summary, Henan Liliang Diamond is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 61% 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.

One more thing: We've identified 2 warning signs with Henan Liliang Diamond (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

While Henan Liliang Diamond 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.