To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. 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 Huadong Medicine (SZSE:000963), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Huadong Medicine:

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

0.16 = CN¥3.7b ÷ (CN¥36b - CN¥13b) (Based on the trailing twelve months to June 2024).

So, Huadong Medicine has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Healthcare industry average of 8.7% it's much better.

Above you can see how the current ROCE for Huadong Medicine compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Huadong Medicine .

What Does the ROCE Trend For Huadong Medicine Tell Us?

In terms of Huadong Medicine's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 16% from 26% five years ago. 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.

The Bottom Line On Huadong Medicine's ROCE

Bringing it all together, while we're somewhat encouraged by Huadong Medicine's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 41% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

One more thing to note, we've identified 1 warning sign with Huadong Medicine and understanding it should be part of your investment process.

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.