Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Shenzhen Honor Electronic (SZSE:300870), it didn't seem to tick all of these boxes.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Shenzhen Honor Electronic is:

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

0.08 = CN¥233m ÷ (CN¥5.1b - CN¥2.2b) (Based on the trailing twelve months to September 2024).

Therefore, Shenzhen Honor Electronic has an ROCE of 8.0%. On its own that's a low return, but compared to the average of 5.8% generated by the Electrical industry, it's much better.

Above you can see how the current ROCE for Shenzhen Honor Electronic compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Shenzhen Honor Electronic .

So How Is Shenzhen Honor Electronic's ROCE Trending?

On the surface, the trend of ROCE at Shenzhen Honor Electronic doesn't inspire confidence. Over the last five years, returns on capital have decreased to 8.0% from 23% five years ago. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Shenzhen Honor Electronic has done well to pay down its current liabilities to 43% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line On Shenzhen Honor Electronic's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Shenzhen Honor Electronic is reinvesting for growth and has higher sales as a result. And there could be an opportunity here if other metrics look good too, because the stock has declined 12% in the last three years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

Like most companies, Shenzhen Honor Electronic does come with some risks, and we've found 2 warning signs that you should be aware of.

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.