If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Shenzhen WOTE Advanced MaterialsLtd (SZSE:002886), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Shenzhen WOTE Advanced MaterialsLtd:

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

0.0083 = CN¥22m ÷ (CN¥3.2b - CN¥657m) (Based on the trailing twelve months to September 2023).

Therefore, Shenzhen WOTE Advanced MaterialsLtd has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Chemicals industry average of 6.0%.

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

What Does the ROCE Trend For Shenzhen WOTE Advanced MaterialsLtd Tell Us?

On the surface, the trend of ROCE at Shenzhen WOTE Advanced MaterialsLtd doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.8% from 7.2% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Shenzhen WOTE Advanced MaterialsLtd has done well to pay down its current liabilities to 20% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line On Shenzhen WOTE Advanced MaterialsLtd's ROCE

In summary, Shenzhen WOTE Advanced MaterialsLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 42% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Shenzhen WOTE Advanced MaterialsLtd (of which 1 is a bit unpleasant!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.