To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. 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 Huagong Tech (SZSE:000988) 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)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Huagong Tech, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥602m ÷ (CN¥17b - CN¥5.3b) (Based on the trailing twelve months to September 2023).
So, Huagong Tech has an ROCE of 5.0%. Even though it's in line with the industry average of 5.1%, it's still a low return by itself.
Above you can see how the current ROCE for Huagong Tech compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Huagong Tech.
What The Trend Of ROCE Can Tell Us
The returns on capital haven't changed much for Huagong Tech in recent years. The company has employed 113% more capital in the last five years, and the returns on that capital have remained stable at 5.0%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
What We Can Learn From Huagong Tech's ROCE
Long story short, while Huagong Tech has been reinvesting its capital, the returns that it's generating haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 117% 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.
On a separate note, we've found 1 warning sign for Huagong Tech you'll probably want to know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
