If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Hangzhou Greenda Electronic Materials (SHSE:603931), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Hangzhou Greenda Electronic Materials, this is the formula:

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

0.11 = CN¥158m ÷ (CN¥1.6b - CN¥180m) (Based on the trailing twelve months to September 2023).

Therefore, Hangzhou Greenda Electronic Materials has an ROCE of 11%. On its own, that's a standard return, however it's much better than the 6.1% generated by the Chemicals industry.

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

The Trend Of ROCE

In terms of Hangzhou Greenda Electronic Materials' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 11% from 21% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hangzhou Greenda Electronic Materials has done well to pay down its current liabilities to 11% 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 Key Takeaway

In summary, we're somewhat concerned by Hangzhou Greenda Electronic Materials' diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last three years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 1 warning sign for Hangzhou Greenda Electronic Materials you'll probably want to know about.

While Hangzhou Greenda Electronic Materials 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.