If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Shenzhen YHLO Biotech (SHSE:688575) and its ROCE trend, we weren't exactly thrilled.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Shenzhen YHLO Biotech, this is the formula:

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

0.076 = CN¥243m ÷ (CN¥4.1b - CN¥888m) (Based on the trailing twelve months to September 2024).

So, Shenzhen YHLO Biotech has an ROCE of 7.6%. On its own that's a low return, but compared to the average of 5.9% generated by the Medical Equipment industry, it's much better.

In the above chart we have measured Shenzhen YHLO Biotech's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shenzhen YHLO Biotech for free.

What Can We Tell From Shenzhen YHLO Biotech's ROCE Trend?

In terms of Shenzhen YHLO Biotech's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.6% from 17% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Shenzhen YHLO Biotech has done well to pay down its current liabilities to 22% 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. 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.

The Bottom Line

We're a bit apprehensive about Shenzhen YHLO Biotech because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last three years have experienced a 24% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

If you'd like to know about the risks facing Shenzhen YHLO Biotech, we've discovered 1 warning sign that you should be aware of.

While Shenzhen YHLO Biotech may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.