What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think ValueHD (SZSE:301318) 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)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ValueHD:

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

0.028 = CN¥49m ÷ (CN¥1.9b - CN¥85m) (Based on the trailing twelve months to September 2023).

Therefore, ValueHD has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Communications industry average of 5.2%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for ValueHD's ROCE against it's prior returns. If you're interested in investigating ValueHD's past further, check out this free graph covering ValueHD's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at ValueHD doesn't inspire confidence. To be more specific, ROCE has fallen from 32% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, ValueHD has done well to pay down its current liabilities to 4.6% 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 ValueHD's ROCE

We're a bit apprehensive about ValueHD because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 13% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

ValueHD does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.