To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, while the ROCE is currently high for Shenzhen Techwinsemi Technology (SZSE:001309), we aren't jumping out of our chairs because returns are decreasing.

Understanding 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. To calculate this metric for Shenzhen Techwinsemi Technology, this is the formula:

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

0.20 = CN¥312m ÷ (CN¥3.8b - CN¥2.3b) (Based on the trailing twelve months to March 2024).

So, Shenzhen Techwinsemi Technology has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Semiconductor industry average of 3.9%.

In the above chart we have measured Shenzhen Techwinsemi Technology's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shenzhen Techwinsemi Technology for free.

What The Trend Of ROCE Can Tell Us

We weren't thrilled with the trend because Shenzhen Techwinsemi Technology's ROCE has reduced by 29% over the last five years, while the business employed 857% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Shenzhen Techwinsemi Technology probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

Another thing to note, Shenzhen Techwinsemi Technology has a high ratio of current liabilities to total assets of 59%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

While returns have fallen for Shenzhen Techwinsemi Technology in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 66% over the last year, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

One final note, you should learn about the 3 warning signs we've spotted with Shenzhen Techwinsemi Technology (including 2 which are a bit concerning) .

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.