To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at China Water Affairs Group (HKG:855), it didn't seem to tick all of these boxes.

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. To calculate this metric for China Water Affairs Group, this is the formula:

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

0.084 = HK$3.7b ÷ (HK$66b - HK$22b) (Based on the trailing twelve months to September 2024).

Thus, China Water Affairs Group has an ROCE of 8.4%. In absolute terms, that's a low return, but it's much better than the Water Utilities industry average of 5.8%.

In the above chart we have measured China Water Affairs Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for China Water Affairs Group .

What Does the ROCE Trend For China Water Affairs Group Tell Us?

The returns on capital haven't changed much for China Water Affairs Group in recent years. The company has employed 62% more capital in the last five years, and the returns on that capital have remained stable at 8.4%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

The Key Takeaway

In conclusion, China Water Affairs Group has been investing more capital into the business, but returns on that capital haven't increased. And investors may be recognizing these trends since the stock has only returned a total of 1.1% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One final note, you should learn about the 3 warning signs we've spotted with China Water Affairs Group (including 2 which make us uncomfortable) .

While China Water Affairs Group 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.