Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Shanghai Newtouch Software (SHSE:688590) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Shanghai Newtouch Software is:

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

0.038 = CN¥77m ÷ (CN¥3.1b - CN¥1.1b) (Based on the trailing twelve months to June 2024).

Therefore, Shanghai Newtouch Software has an ROCE of 3.8%. Even though it's in line with the industry average of 3.8%, it's still a low return by itself.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how Shanghai Newtouch Software has performed in the past in other metrics, you can view this free graph of Shanghai Newtouch Software's past earnings, revenue and cash flow.

What Does the ROCE Trend For Shanghai Newtouch Software Tell Us?

When we looked at the ROCE trend at Shanghai Newtouch Software, we didn't gain much confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 3.8%. 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 side note, Shanghai Newtouch Software has done well to pay down its current liabilities to 34% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Shanghai Newtouch Software's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Shanghai Newtouch Software. These trends are starting to be recognized by investors since the stock has delivered a 9.5% gain to shareholders who've held over the last three years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you want to know some of the risks facing Shanghai Newtouch Software we've found 5 warning signs (3 are a bit concerning!) that you should be aware of before investing here.

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.