To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Speaking of which, we noticed some great changes in Shenzhen Zhongheng Huafa's (SZSE:000020) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Shenzhen Zhongheng Huafa is:

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

0.05 = CN¥19m ÷ (CN¥593m - CN¥218m) (Based on the trailing twelve months to March 2024).

Therefore, Shenzhen Zhongheng Huafa has an ROCE of 5.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.2%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shenzhen Zhongheng Huafa's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Shenzhen Zhongheng Huafa.

So How Is Shenzhen Zhongheng Huafa's ROCE Trending?

Shenzhen Zhongheng Huafa is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 28% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

What We Can Learn From Shenzhen Zhongheng Huafa's ROCE

As discussed above, Shenzhen Zhongheng Huafa appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. With that in mind, we believe the promising trends warrant this stock for further investigation.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for 000020 on our platform that is definitely worth checking out.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.