To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Having said that, from a first glance at Changzhou Xiangming Intelligent Drive System (SZSE:301226) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on Changzhou Xiangming Intelligent Drive System is:

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

0.0083 = CN¥7.5m ÷ (CN¥1.0b - CN¥125m) (Based on the trailing twelve months to September 2024).

So, Changzhou Xiangming Intelligent Drive System has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 5.8%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Changzhou Xiangming Intelligent Drive System's past further, check out this free graph covering Changzhou Xiangming Intelligent Drive System's past earnings, revenue and cash flow.

So How Is Changzhou Xiangming Intelligent Drive System's ROCE Trending?

On the surface, the trend of ROCE at Changzhou Xiangming Intelligent Drive System doesn't inspire confidence. Over the last five years, returns on capital have decreased to 0.8% from 15% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Changzhou Xiangming Intelligent Drive System has done well to pay down its current liabilities to 12% 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. 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.

What We Can Learn From Changzhou Xiangming Intelligent Drive System's ROCE

In summary, we're somewhat concerned by Changzhou Xiangming Intelligent Drive System's diminishing returns on increasing amounts of capital. However the stock has delivered a 22% return to shareholders over the last year, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Changzhou Xiangming Intelligent Drive System does have some risks, we noticed 4 warning signs (and 2 which make us uncomfortable) we think you should know about.

While Changzhou Xiangming Intelligent Drive 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.