If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after investigating Hubei W-olf Photoelectric Technology (SZSE:002962), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Hubei W-olf Photoelectric Technology:

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

0.01 = CN¥19m ÷ (CN¥2.0b - CN¥157m) (Based on the trailing twelve months to September 2023).

Thus, Hubei W-olf Photoelectric Technology has an ROCE of 1.0%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 6.2%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hubei W-olf Photoelectric Technology'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 Hubei W-olf Photoelectric Technology.

What Does the ROCE Trend For Hubei W-olf Photoelectric Technology Tell Us?

On the surface, the trend of ROCE at Hubei W-olf Photoelectric Technology doesn't inspire confidence. Over the last five years, returns on capital have decreased to 1.0% from 18% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Hubei W-olf Photoelectric Technology has done well to pay down its current liabilities to 7.8% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

We're a bit apprehensive about Hubei W-olf Photoelectric Technology because despite more capital being deployed in the business, returns on that capital and sales have both fallen. However the stock has delivered a 26% return to shareholders over the last three years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know more about Hubei W-olf Photoelectric Technology, we've spotted 4 warning signs, and 1 of them makes us a bit uncomfortable.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com