What are the early trends we should look for to identify a stock that could 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Fangda Special Steel Technology (SHSE:600507) 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)?

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 Fangda Special Steel Technology, this is the formula:

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

0.038 = CN¥390m ÷ (CN¥22b - CN¥12b) (Based on the trailing twelve months to September 2024).

Thus, Fangda Special Steel Technology has an ROCE of 3.8%. In absolute terms, that's a low return and it also under-performs the Metals and Mining industry average of 6.8%.

In the above chart we have measured Fangda Special Steel Technology'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 Fangda Special Steel Technology for free.

What Can We Tell From Fangda Special Steel Technology's ROCE Trend?

When we looked at the ROCE trend at Fangda Special Steel Technology, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 3.8% from 35% 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, Fangda Special Steel Technology's current liabilities are still rather high at 53% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Fangda Special Steel Technology's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 12% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Fangda Special Steel Technology (including 1 which makes us a bit uncomfortable) .

While Fangda Special Steel Technology 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.