If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Shandong HaihuaLtd (SZSE:000822) so let's look a bit deeper.

Understanding 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. The formula for this calculation on Shandong HaihuaLtd is:

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

0.19 = CN¥1.1b ÷ (CN¥8.3b - CN¥2.4b) (Based on the trailing twelve months to June 2024).

Thus, Shandong HaihuaLtd has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 5.5% it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shandong HaihuaLtd's ROCE against it's prior returns. If you're interested in investigating Shandong HaihuaLtd's past further, check out this free graph covering Shandong HaihuaLtd's past earnings, revenue and cash flow.

What Can We Tell From Shandong HaihuaLtd's ROCE Trend?

Shandong HaihuaLtd is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 19%. Basically the business is earning more per dollar of capital invested and in addition to that, 64% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 29% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line

In summary, it's great to see that Shandong HaihuaLtd can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has only returned 22% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So with that in mind, we think the stock deserves further research.

One more thing: We've identified 2 warning signs with Shandong HaihuaLtd (at least 1 which is potentially serious) , and understanding these would certainly be useful.

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.