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. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Hengyi Petrochemical (SZSE:000703), we don't think it's current trends fit the mold of a multi-bagger.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Hengyi Petrochemical, this is the formula:

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

0.054 = CN¥2.9b ÷ (CN¥110b - CN¥56b) (Based on the trailing twelve months to March 2024).

Thus, Hengyi Petrochemical has an ROCE of 5.4%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.5%.

Above you can see how the current ROCE for Hengyi Petrochemical 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 Hengyi Petrochemical for free.

How Are Returns Trending?

The returns on capital haven't changed much for Hengyi Petrochemical in recent years. The company has employed 34% more capital in the last five years, and the returns on that capital have remained stable at 5.4%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 51% of total assets, this reported ROCE would probably be less than5.4% because total capital employed would be higher.The 5.4% ROCE could be even lower if current liabilities weren't 51% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

In Conclusion...

In conclusion, Hengyi Petrochemical has been investing more capital into the business, but returns on that capital haven't increased. And investors appear hesitant that the trends will pick up because the stock has fallen 26% in the last five years. 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.

If you want to know some of the risks facing Hengyi Petrochemical we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.

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