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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at GCH Technology (SHSE:688625), it didn't seem to tick all of these boxes.

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

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

0.19 = CN¥242m ÷ (CN¥2.9b - CN¥1.6b) (Based on the trailing twelve months to March 2024).

Therefore, GCH Technology has an ROCE of 19%. 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 GCH Technology's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for GCH Technology .

So How Is GCH Technology's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 36% five years ago, while the business's capital employed increased by 476%. That being said, GCH Technology raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence GCH Technology might not have received a full period of earnings contribution from it.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 56%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that GCH Technology is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 37% over the last three years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing: We've identified 2 warning signs with GCH Technology (at least 1 which is potentially serious) , and understanding them would certainly be useful.

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.

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