To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Having said that, from a first glance at Three Squirrels (SZSE:300783) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Three Squirrels, this is the formula:

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

0.11 = CN¥324m ÷ (CN¥4.6b - CN¥1.5b) (Based on the trailing twelve months to September 2024).

Thus, Three Squirrels has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Food industry average of 6.9% it's much better.

Above you can see how the current ROCE for Three Squirrels 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 Three Squirrels for free.

So How Is Three Squirrels' ROCE Trending?

On the surface, the trend of ROCE at Three Squirrels doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Three Squirrels is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 57% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing to note, we've identified 3 warning signs with Three Squirrels and understanding them should be part of your investment process.

While Three Squirrels 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.