There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Suzhou Iron TechnologyLTD (SHSE:688329) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Suzhou Iron TechnologyLTD:

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

0.10 = CN¥92m ÷ (CN¥1.4b - CN¥540m) (Based on the trailing twelve months to September 2023).

Therefore, Suzhou Iron TechnologyLTD has an ROCE of 10%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 8.0% it's much better.

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 Suzhou Iron TechnologyLTD has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is Suzhou Iron TechnologyLTD's ROCE Trending?

When we looked at the ROCE trend at Suzhou Iron TechnologyLTD, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 10% from 14% five years ago. 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 37%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 10%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Suzhou Iron TechnologyLTD's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 65% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Suzhou Iron TechnologyLTD has the makings of a multi-bagger.

One more thing, we've spotted 3 warning signs facing Suzhou Iron TechnologyLTD that you might find interesting.

While Suzhou Iron TechnologyLTD 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.