What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 Shanghai Sanyou Medical (SHSE:688085) 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 who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Shanghai Sanyou Medical, this is the formula:

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

0.058 = CN¥117m ÷ (CN¥2.2b - CN¥155m) (Based on the trailing twelve months to December 2023).

Therefore, Shanghai Sanyou Medical has an ROCE of 5.8%. In absolute terms, that's a low return and it also under-performs the Medical Equipment industry average of 8.2%.

In the above chart we have measured Shanghai Sanyou Medical's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shanghai Sanyou Medical for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Shanghai Sanyou Medical doesn't inspire confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 5.8%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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.

What We Can Learn From Shanghai Sanyou Medical's ROCE

In summary, we're somewhat concerned by Shanghai Sanyou Medical's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 44% over the last three years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you'd like to know about the risks facing Shanghai Sanyou Medical, we've discovered 2 warning signs that you should be aware of.

While Shanghai Sanyou Medical 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.