What trends should we look for it we want to identify stocks that can 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Shenzhen Kaifa Technology (SZSE:000021), it didn't seem to tick all of these boxes.

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

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 Shenzhen Kaifa Technology:

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

0.05 = CN¥800m ÷ (CN¥27b - CN¥11b) (Based on the trailing twelve months to September 2023).

So, Shenzhen Kaifa Technology has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.3%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Kaifa Technology's ROCE against it's prior returns. If you'd like to look at how Shenzhen Kaifa Technology has performed in the past in other metrics, you can view this free graph of Shenzhen Kaifa Technology's past earnings, revenue and cash flow.

So How Is Shenzhen Kaifa Technology's ROCE Trending?

On the surface, the trend of ROCE at Shenzhen Kaifa Technology doesn't inspire confidence. Around five years ago the returns on capital were 8.5%, but since then they've fallen to 5.0%. 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 Kaifa Technology has done well to pay down its current liabilities to 40% of total assets. That could partly explain why the ROCE has dropped. 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 Key Takeaway

To conclude, we've found that Shenzhen Kaifa Technology is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 75% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

One more thing, we've spotted 2 warning signs facing Shenzhen Kaifa Technology that you might find interesting.

While Shenzhen Kaifa Technology may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.