What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Henan Liliang Diamond (SZSE:301071) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Henan Liliang Diamond:

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

0.059 = CN¥344m ÷ (CN¥6.6b - CN¥754m) (Based on the trailing twelve months to March 2024).

Therefore, Henan Liliang Diamond has an ROCE of 5.9%. Even though it's in line with the industry average of 5.5%, it's still a low return by itself.

Above you can see how the current ROCE for Henan Liliang Diamond compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Henan Liliang Diamond for free.

What Can We Tell From Henan Liliang Diamond's ROCE Trend?

When we looked at the ROCE trend at Henan Liliang Diamond, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Henan Liliang Diamond 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. 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 Henan Liliang Diamond's ROCE

To conclude, we've found that Henan Liliang Diamond is reinvesting in the business, but returns have been falling. And in the last year, the stock has given away 30% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

One more thing: We've identified 2 warning signs with Henan Liliang Diamond (at least 1 which is potentially serious) , and understanding them would certainly be useful.

While Henan Liliang Diamond isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.