If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Hengong Precision Equipment (SZSE:301261), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Hengong Precision Equipment:

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

0.071 = CN¥125m ÷ (CN¥3.0b - CN¥1.2b) (Based on the trailing twelve months to September 2024).

So, Hengong Precision Equipment has an ROCE of 7.1%. On its own that's a low return on capital but it's in line with the industry's average returns of 6.8%.

In the above chart we have measured Hengong Precision Equipment's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Hengong Precision Equipment .

So How Is Hengong Precision Equipment's ROCE Trending?

On the surface, the trend of ROCE at Hengong Precision Equipment doesn't inspire confidence. Around five years ago the returns on capital were 22%, but since then they've fallen to 7.1%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a separate but related note, it's important to know that Hengong Precision Equipment has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Hengong Precision Equipment. And the stock has followed suit returning a meaningful 66% to shareholders over the last year. So should these growth trends continue, we'd be optimistic on the stock going forward.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Hengong Precision Equipment (of which 2 can't be ignored!) that you should know about.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.