If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. However, after briefly looking over the numbers, we don't think Zhende Medical (SHSE:603301) 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 Zhende Medical is:

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

0.11 = CN¥658m ÷ (CN¥7.4b - CN¥1.6b) (Based on the trailing twelve months to September 2022).

Thus, Zhende Medical has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Medical Equipment industry average of 9.2% it's much better.

Above you can see how the current ROCE for Zhende Medical compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Zhende Medical for free.

How Are Returns Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 26% five years ago, while the business's capital employed increased by 876%. That being said, Zhende Medical raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Zhende Medical might not have received a full period of earnings contribution from it.

On a side note, Zhende Medical has done well to pay down its current liabilities to 21% 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. 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.

In Conclusion...

In summary, we're somewhat concerned by Zhende Medical's diminishing returns on increasing amounts of capital. Despite the concerning underlying trends, the stock has actually gained 35% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

On a final note, we found 4 warning signs for Zhende Medical (2 are significant) you should be aware of.

While Zhende 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.