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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Speaking of which, we noticed some great changes in Shanghai Pret Composites' (SZSE:002324) returns on capital, so let's have a look.

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

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 Shanghai Pret Composites:

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

0.09 = CN¥545m ÷ (CN¥12b - CN¥6.0b) (Based on the trailing twelve months to March 2024).

So, Shanghai Pret Composites has an ROCE of 9.0%. On its own that's a low return, but compared to the average of 5.5% generated by the Chemicals industry, it's much better.

Above you can see how the current ROCE for Shanghai Pret Composites 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 Shanghai Pret Composites for free.

What Does the ROCE Trend For Shanghai Pret Composites Tell Us?

Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 9.0%. Basically the business is earning more per dollar of capital invested and in addition to that, 153% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 50% of the business, which is more than it was five years ago. Given it's pretty high ratio, we'd remind investors that having current liabilities at those levels can bring about some risks in certain businesses.

What We Can Learn From Shanghai Pret Composites' ROCE

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Shanghai Pret Composites has. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 36% to shareholders. So with that in mind, we think the stock deserves further research.

On a separate note, we've found 1 warning sign for Shanghai Pret Composites you'll probably want to know about.

While Shanghai Pret Composites isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.