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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Lihuayi Weiyuan Chemical (SHSE:600955) and its ROCE trend, we weren't exactly thrilled.

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 Lihuayi Weiyuan Chemical, this is the formula:

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

0.0085 = CN¥97m ÷ (CN¥14b - CN¥2.1b) (Based on the trailing twelve months to September 2024).

Thus, Lihuayi Weiyuan Chemical has an ROCE of 0.9%. Ultimately, that's a low return and it under-performs 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 Lihuayi Weiyuan Chemical's past further, check out this free graph covering Lihuayi Weiyuan Chemical's past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Lihuayi Weiyuan Chemical, we didn't gain much confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 0.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Lihuayi Weiyuan Chemical has done well to pay down its current liabilities to 16% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Key Takeaway

While returns have fallen for Lihuayi Weiyuan Chemical in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. However, despite the promising trends, the stock has fallen 65% over the last three years, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Lihuayi Weiyuan Chemical does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

While Lihuayi Weiyuan Chemical 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.