If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. However, after investigating Wuxi Xinhongye Wire & Cable (SZSE:301310), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Wuxi Xinhongye Wire & Cable is:

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

0.039 = CN¥90m ÷ (CN¥4.0b - CN¥1.7b) (Based on the trailing twelve months to September 2024).

So, Wuxi Xinhongye Wire & Cable has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.8%.

Above you can see how the current ROCE for Wuxi Xinhongye Wire & Cable compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Wuxi Xinhongye Wire & Cable for free.

How Are Returns Trending?

On the surface, the trend of ROCE at Wuxi Xinhongye Wire & Cable doesn't inspire confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 3.9%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Wuxi Xinhongye Wire & Cable has decreased its current liabilities to 42% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Wuxi Xinhongye Wire & Cable. However, despite the promising trends, the stock has fallen 16% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Wuxi Xinhongye Wire & Cable does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is significant...

While Wuxi Xinhongye Wire & Cable 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.