If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Shanghai Dragon (SHSE:600630) so let's look a bit deeper.

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 Shanghai Dragon:

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

0.067 = CN¥61m ÷ (CN¥1.7b - CN¥746m) (Based on the trailing twelve months to March 2024).

Thus, Shanghai Dragon has an ROCE of 6.7%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.7%.

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

The Trend Of ROCE

Shanghai Dragon has not disappointed in regards to ROCE growth. The data shows that returns on capital have increased by 471% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. In regards to capital employed, Shanghai Dragon appears to been achieving more with less, since the business is using 50% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

Another thing to note, Shanghai Dragon has a high ratio of current liabilities to total assets of 45%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Shanghai Dragon's ROCE

In summary, it's great to see that Shanghai Dragon has been able to turn things around and earn higher returns on lower amounts of capital. Since the stock has only returned 17% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

One more thing, we've spotted 1 warning sign facing Shanghai Dragon that you might find interesting.

While Shanghai Dragon 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.