What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at Luyan PharmaLtd (SZSE:002788), it didn't seem to tick all of these boxes.

Understanding 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 Luyan PharmaLtd is:

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

0.18 = CN¥702m ÷ (CN¥12b - CN¥8.0b) (Based on the trailing twelve months to June 2024).

So, Luyan PharmaLtd has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Healthcare industry.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Luyan PharmaLtd's ROCE against it's prior returns. If you'd like to look at how Luyan PharmaLtd has performed in the past in other metrics, you can view this free graph of Luyan PharmaLtd's past earnings, revenue and cash flow.

So How Is Luyan PharmaLtd's ROCE Trending?

When we looked at the ROCE trend at Luyan PharmaLtd, we didn't gain much confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 18%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Luyan PharmaLtd's current liabilities are still rather high at 67% of total assets. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Luyan PharmaLtd's ROCE

In summary, Luyan PharmaLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly, the stock has only gained 33% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

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

While Luyan PharmaLtd 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.