If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Speaking of which, we noticed some great changes in New Hope Dairy's (SZSE:002946) returns on capital, so let's have a look.

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. To calculate this metric for New Hope Dairy, this is the formula:

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

0.15 = CN¥735m ÷ (CN¥9.1b - CN¥4.0b) (Based on the trailing twelve months to June 2024).

Therefore, New Hope Dairy has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 6.8% it's much better.

Above you can see how the current ROCE for New Hope Dairy 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 New Hope Dairy for free.

How Are Returns Trending?

We like the trends that we're seeing from New Hope Dairy. Over the last five years, returns on capital employed have risen substantially to 15%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 117%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

On a separate but related note, it's important to know that New Hope Dairy has a current liabilities to total assets ratio of 44%, which we'd consider pretty high. 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.

In Conclusion...

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what New Hope Dairy has. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

One more thing to note, we've identified 2 warning signs with New Hope Dairy and understanding these should be part of your investment process.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.