There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Shenzhen YHLO Biotech (SHSE:688575) and its ROCE trend, we weren't exactly thrilled.

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. The formula for this calculation on Shenzhen YHLO Biotech is:

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

0.059 = CN¥181m ÷ (CN¥3.9b - CN¥792m) (Based on the trailing twelve months to March 2024).

Thus, Shenzhen YHLO Biotech has an ROCE of 5.9%. Even though it's in line with the industry average of 6.4%, it's still a low return by itself.

Above you can see how the current ROCE for Shenzhen YHLO Biotech compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Shenzhen YHLO Biotech .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shenzhen YHLO Biotech, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.9% from 13% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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, Shenzhen YHLO Biotech has done well to pay down its current liabilities to 21% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

What We Can Learn From Shenzhen YHLO Biotech's ROCE

In summary, we're somewhat concerned by Shenzhen YHLO Biotech's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 20% from where it was three years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a final note, we found 2 warning signs for Shenzhen YHLO Biotech (1 makes us a bit uncomfortable) you should be aware of.

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.