To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. However, after investigating Shanghai Fengyuzhu Culture Technology (SHSE:603466), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Shanghai Fengyuzhu Culture Technology, this is the formula:

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

0.04 = CN¥120m ÷ (CN¥4.7b - CN¥1.7b) (Based on the trailing twelve months to March 2024).

Thus, Shanghai Fengyuzhu Culture Technology has an ROCE of 4.0%. On its own that's a low return on capital but it's in line with the industry's average returns of 4.1%.

Above you can see how the current ROCE for Shanghai Fengyuzhu Culture Technology 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 Shanghai Fengyuzhu Culture Technology .

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Shanghai Fengyuzhu Culture Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.0% from 14% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Shanghai Fengyuzhu Culture Technology has decreased its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

In summary, despite lower returns in the short term, we're encouraged to see that Shanghai Fengyuzhu Culture Technology is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 13% over the last five 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.

On a final note, we found 2 warning signs for Shanghai Fengyuzhu Culture Technology (1 is significant) you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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