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. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Zhejiang Mustang BatteryLtd (SHSE:605378), we don't think it's current trends fit the mold of a multi-bagger.

Return On Capital Employed (ROCE): What Is It?

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 Zhejiang Mustang BatteryLtd is:

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

0.078 = CN¥98m ÷ (CN¥1.6b - CN¥313m) (Based on the trailing twelve months to September 2023).

So, Zhejiang Mustang BatteryLtd has an ROCE of 7.8%. On its own that's a low return, but compared to the average of 4.8% generated by the Household Products industry, 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 Zhejiang Mustang BatteryLtd has performed in the past in other metrics, you can view this free graph of Zhejiang Mustang BatteryLtd's past earnings, revenue and cash flow.

What Can We Tell From Zhejiang Mustang BatteryLtd's ROCE Trend?

On the surface, the trend of ROCE at Zhejiang Mustang BatteryLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.8% from 24% five years ago. 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 related note, Zhejiang Mustang BatteryLtd has decreased its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

In summary, we're somewhat concerned by Zhejiang Mustang BatteryLtd's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last year have experienced a 20% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Zhejiang Mustang BatteryLtd does have some risks, we noticed 3 warning signs (and 1 which doesn't sit too well with us) we think you should know about.

While Zhejiang Mustang BatteryLtd isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.