If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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 investigating Longkou Union Chemical (SZSE:301209), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Longkou Union Chemical:

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

0.059 = CN¥42m ÷ (CN¥828m - CN¥119m) (Based on the trailing twelve months to June 2024).

Therefore, Longkou Union Chemical has an ROCE of 5.9%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.5%.

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're interested in investigating Longkou Union Chemical's past further, check out this free graph covering Longkou Union Chemical's past earnings, revenue and cash flow.

What Can We Tell From Longkou Union Chemical's ROCE Trend?

On the surface, the trend of ROCE at Longkou Union Chemical doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.9% from 19% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Longkou Union Chemical has done well to pay down its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Longkou Union Chemical. These trends are starting to be recognized by investors since the stock has delivered a 1.4% gain to shareholders who've held over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

Longkou Union Chemical does have some risks, we noticed 3 warning signs (and 1 which can't be ignored) we think you should know about.

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.