What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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 Shanghai Hollywave Electronic System (SHSE:688682) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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 Shanghai Hollywave Electronic System, this is the formula:

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

0.023 = CN¥16m ÷ (CN¥937m - CN¥224m) (Based on the trailing twelve months to September 2024).

So, Shanghai Hollywave Electronic System has an ROCE of 2.3%. Even though it's in line with the industry average of 2.3%, it's still a low return by itself.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanghai Hollywave Electronic System's ROCE against it's prior returns. If you'd like to look at how Shanghai Hollywave Electronic System has performed in the past in other metrics, you can view this free graph of Shanghai Hollywave Electronic System's past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Shanghai Hollywave Electronic System doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.3% from 21% 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Shanghai Hollywave Electronic System has done well to pay down its current liabilities to 24% 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.

What We Can Learn From Shanghai Hollywave Electronic System's ROCE

In summary, Shanghai Hollywave Electronic System is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last three years, the stock has given away 45% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Shanghai Hollywave Electronic System has the makings of a multi-bagger.

Shanghai Hollywave Electronic System does have some risks, we noticed 4 warning signs (and 2 which are potentially serious) we think you should know about.

While Shanghai Hollywave Electronic System 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.