Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Although, when we looked at Anhui Honglu Steel Construction(Group) (SZSE:002541), it didn't seem to tick all of these boxes.

What Is Return On Capital Employed (ROCE)?

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 Anhui Honglu Steel Construction(Group), this is the formula:

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

0.076 = CN¥1.2b ÷ (CN¥24b - CN¥8.3b) (Based on the trailing twelve months to March 2024).

Thus, Anhui Honglu Steel Construction(Group) has an ROCE of 7.6%. On its own, that's a low figure but it's around the 6.7% average generated by the Metals and Mining industry.

Above you can see how the current ROCE for Anhui Honglu Steel Construction(Group) compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Anhui Honglu Steel Construction(Group) .

The Trend Of ROCE

There are better returns on capital out there than what we're seeing at Anhui Honglu Steel Construction(Group). The company has employed 196% more capital in the last five years, and the returns on that capital have remained stable at 7.6%. 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.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 35% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

In Conclusion...

Long story short, while Anhui Honglu Steel Construction(Group) has been reinvesting its capital, the returns that it's generating haven't increased. Yet to long term shareholders the stock has gifted them an incredible 152% return in the last five years, so the market appears to be rosy about its future. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing: We've identified 3 warning signs with Anhui Honglu Steel Construction(Group) (at least 1 which is a bit unpleasant) , and understanding these would certainly be useful.

While Anhui Honglu Steel Construction(Group) 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.

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