What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. In light of that, when we looked at Zhejiang Asia-Pacific Mechanical & ElectronicLtd (SZSE:002284) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Zhejiang Asia-Pacific Mechanical & ElectronicLtd:

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

0.027 = CN¥79m ÷ (CN¥6.8b - CN¥3.8b) (Based on the trailing twelve months to September 2023).

So, Zhejiang Asia-Pacific Mechanical & ElectronicLtd has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 5.8%.

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 Zhejiang Asia-Pacific Mechanical & ElectronicLtd has performed in the past in other metrics, you can view this free graph of Zhejiang Asia-Pacific Mechanical & ElectronicLtd's past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

We've noticed that although returns on capital are flat over the last five years, the amount of capital employed in the business has fallen 22% in that same period. To us that doesn't look like a multi-bagger because the company appears to be selling assets and it's returns aren't increasing. In addition to that, since the ROCE doesn't scream "quality" at 2.7%, it's hard to get excited about these developments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 56% of total assets, this reported ROCE would probably be less than2.7% because total capital employed would be higher.The 2.7% ROCE could be even lower if current liabilities weren't 56% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

What We Can Learn From Zhejiang Asia-Pacific Mechanical & ElectronicLtd's ROCE

It's a shame to see that Zhejiang Asia-Pacific Mechanical & ElectronicLtd is effectively shrinking in terms of its capital base. And with the stock having returned a mere 31% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One more thing to note, we've identified 1 warning sign with Zhejiang Asia-Pacific Mechanical & ElectronicLtd and understanding it should be part of your investment process.

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.