Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Shenzhen Gas (SHSE:601139) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Shenzhen Gas is:

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

0.08 = CN¥1.9b ÷ (CN¥46b - CN¥22b) (Based on the trailing twelve months to March 2024).

Thus, Shenzhen Gas has an ROCE of 8.0%. On its own, that's a low figure but it's around the 9.2% average generated by the Gas Utilities industry.

In the above chart we have measured Shenzhen Gas' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Shenzhen Gas .

What The Trend Of ROCE Can Tell Us

The returns on capital haven't changed much for Shenzhen Gas in recent years. The company has consistently earned 8.0% for the last five years, and the capital employed within the business has risen 74% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 48% of total assets, this reported ROCE would probably be less than8.0% because total capital employed would be higher.The 8.0% ROCE could be even lower if current liabilities weren't 48% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Bottom Line

As we've seen above, Shenzhen Gas' returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 55% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you'd like to know about the risks facing Shenzhen Gas, we've discovered 1 warning sign that you should be aware of.

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.