Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Namchow Food Group (Shanghai) (SHSE:605339) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. The formula for this calculation on Namchow Food Group (Shanghai) is:

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

0.037 = CN¥122m ÷ (CN¥4.1b - CN¥765m) (Based on the trailing twelve months to September 2023).

Thus, Namchow Food Group (Shanghai) has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Food industry average of 7.6%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Namchow Food Group (Shanghai)'s ROCE against it's prior returns. If you'd like to look at how Namchow Food Group (Shanghai) has performed in the past in other metrics, you can view this free graph of Namchow Food Group (Shanghai)'s past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Namchow Food Group (Shanghai), we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.7% from 17% 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 may take some time before the company starts to see any change in earnings from these investments.

On a related note, Namchow Food Group (Shanghai) has decreased its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line On Namchow Food Group (Shanghai)'s ROCE

In summary, Namchow Food Group (Shanghai) 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 31% over the last year, investors may not be too optimistic on this trend improving either. 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.

One more thing to note, we've identified 2 warning signs with Namchow Food Group (Shanghai) and understanding them should be part of your investment process.

While Namchow Food Group (Shanghai) 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.