There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Having said that, from a first glance at Shandong Hualu-Hengsheng Chemical (SHSE:600426) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Shandong Hualu-Hengsheng Chemical:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥5.0b ÷ (CN¥45b - CN¥5.3b) (Based on the trailing twelve months to March 2024).
So, Shandong Hualu-Hengsheng Chemical has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.
In the above chart we have measured Shandong Hualu-Hengsheng Chemical'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 Shandong Hualu-Hengsheng Chemical for free.
The Trend Of ROCE
On the surface, the trend of ROCE at Shandong Hualu-Hengsheng Chemical doesn't inspire confidence. Over the last five years, returns on capital have decreased to 13% from 24% five years ago. However it looks like Shandong Hualu-Hengsheng Chemical might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On Shandong Hualu-Hengsheng Chemical's ROCE
To conclude, we've found that Shandong Hualu-Hengsheng Chemical is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 188% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a final note, we found 2 warning signs for Shandong Hualu-Hengsheng Chemical (1 is concerning) you should be aware of.
While Shandong Hualu-Hengsheng Chemical 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.