If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. That's why when we briefly looked at Xiamen Faratronic's (SHSE:600563) ROCE trend, we were very happy with what we saw.

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. The formula for this calculation on Xiamen Faratronic is:

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

0.21 = CN¥1.1b ÷ (CN¥6.6b - CN¥1.6b) (Based on the trailing twelve months to June 2024).

So, Xiamen Faratronic has an ROCE of 21%. That's a fantastic return and not only that, it outpaces the average of 5.4% earned by companies in a similar industry.

Above you can see how the current ROCE for Xiamen Faratronic 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 Xiamen Faratronic for free.

So How Is Xiamen Faratronic's ROCE Trending?

We'd be pretty happy with returns on capital like Xiamen Faratronic. Over the past five years, ROCE has remained relatively flat at around 21% and the business has deployed 104% more capital into its operations. Now considering ROCE is an attractive 21%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 24% of total assets, this reported ROCE would probably be less than21% because total capital employed would be higher.The 21% ROCE could be even lower if current liabilities weren't 24% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.

The Bottom Line

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 155% return to those who've held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation for 600563 that compares the share price and estimated value.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.