Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Dirui IndustrialLtd (SZSE:300396), we don't think it's current trends fit the mold of a multi-bagger.

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 Dirui IndustrialLtd is:

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

0.099 = CN¥213m ÷ (CN¥3.1b - CN¥928m) (Based on the trailing twelve months to September 2024).

Thus, Dirui IndustrialLtd has an ROCE of 9.9%. In absolute terms, that's a low return, but it's much better than the Medical Equipment industry average of 5.9%.

Above you can see how the current ROCE for Dirui IndustrialLtd 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 Dirui IndustrialLtd .

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Dirui IndustrialLtd doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Dirui IndustrialLtd's current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 9.9%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

To conclude, we've found that Dirui IndustrialLtd is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 19% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

One more thing: We've identified 2 warning signs with Dirui IndustrialLtd (at least 1 which is a bit concerning) , and understanding them would certainly be useful.

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.