If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. In light of that, when we looked at Taiyuan Heavy Industry (SHSE:600169) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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 Taiyuan Heavy Industry:

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

0.034 = CN¥576m ÷ (CN¥33b - CN¥16b) (Based on the trailing twelve months to September 2023).

So, Taiyuan Heavy Industry has an ROCE of 3.4%. Ultimately, that's a low return and it under-performs the Machinery 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 Taiyuan Heavy Industry's ROCE against it's prior returns. If you're interested in investigating Taiyuan Heavy Industry's past further, check out this free graph covering Taiyuan Heavy Industry's past earnings, revenue and cash flow.

What Can We Tell From Taiyuan Heavy Industry's ROCE Trend?

When we looked at the ROCE trend at Taiyuan Heavy Industry, we didn't gain much confidence. Around five years ago the returns on capital were 10%, but since then they've fallen to 3.4%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 related note, Taiyuan Heavy Industry has decreased its current liabilities to 48% 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line On Taiyuan Heavy Industry's ROCE

Bringing it all together, while we're somewhat encouraged by Taiyuan Heavy Industry's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 27% in the last five years. Therefore based on the analysis done in this article, we don't think Taiyuan Heavy Industry has the makings of a multi-bagger.

If you'd like to know more about Taiyuan Heavy Industry, we've spotted 2 warning signs, and 1 of them shouldn't be ignored.

While Taiyuan Heavy Industry 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.