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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Weichai Heavy Machinery (SZSE:000880) looks quite promising in regards to its trends of return on capital.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Weichai Heavy Machinery is:

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

0.02 = CN¥46m ÷ (CN¥5.5b - CN¥3.2b) (Based on the trailing twelve months to March 2024).

So, Weichai Heavy Machinery has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 5.7%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Weichai Heavy Machinery's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Weichai Heavy Machinery.

How Are Returns Trending?

The fact that Weichai Heavy Machinery is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 2.0% on its capital. And unsurprisingly, like most companies trying to break into the black, Weichai Heavy Machinery is utilizing 43% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a separate but related note, it's important to know that Weichai Heavy Machinery has a current liabilities to total assets ratio of 58%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Key Takeaway

To the delight of most shareholders, Weichai Heavy Machinery has now broken into profitability. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 45% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you'd like to know about the risks facing Weichai Heavy Machinery, we've discovered 2 warning signs that you should be aware of.

While Weichai Heavy Machinery 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.