If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Hengdian Group Tospo Lighting (SHSE:603303), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Hengdian Group Tospo Lighting, this is the formula:

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

0.085 = CN¥298m ÷ (CN¥6.2b - CN¥2.6b) (Based on the trailing twelve months to June 2024).

So, Hengdian Group Tospo Lighting has an ROCE of 8.5%. On its own that's a low return, but compared to the average of 5.9% generated by the Electrical industry, it's much better.

In the above chart we have measured Hengdian Group Tospo Lighting's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hengdian Group Tospo Lighting .

What The Trend Of ROCE Can Tell Us

There are better returns on capital out there than what we're seeing at Hengdian Group Tospo Lighting. Over the past five years, ROCE has remained relatively flat at around 8.5% and the business has deployed 42% more capital into its operations. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

On a separate but related note, it's important to know that Hengdian Group Tospo Lighting has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Hengdian Group Tospo Lighting's ROCE

In conclusion, Hengdian Group Tospo Lighting has been investing more capital into the business, but returns on that capital haven't increased. Since the stock has gained an impressive 40% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One more thing to note, we've identified 2 warning signs with Hengdian Group Tospo Lighting and understanding these should be part of your investment process.

While Hengdian Group Tospo Lighting isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.