There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Shenzhen Han's CNC Technology (SZSE:301200), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Shenzhen Han's CNC Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = CN¥200m ÷ (CN¥6.1b - CN¥1b) (Based on the trailing twelve months to September 2023).
Thus, Shenzhen Han's CNC Technology has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.0%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Shenzhen Han's CNC Technology's past further, check out this free graph covering Shenzhen Han's CNC Technology's past earnings, revenue and cash flow.
How Are Returns Trending?
On the surface, the trend of ROCE at Shenzhen Han's CNC Technology doesn't inspire confidence. Over the last four years, returns on capital have decreased to 3.9% from 17% four years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
On a related note, Shenzhen Han's CNC Technology has decreased its current liabilities to 16% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Our Take On Shenzhen Han's CNC Technology's ROCE
In summary, we're somewhat concerned by Shenzhen Han's CNC Technology's diminishing returns on increasing amounts of capital. It should come as no surprise then that the stock has fallen 21% over the last year, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
One final note, you should learn about the 3 warning signs we've spotted with Shenzhen Han's CNC Technology (including 1 which doesn't sit too well with us) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.