To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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 Road Environment Technology.Ltd (SHSE:688156), 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. To calculate this metric for Road Environment Technology.Ltd, this is the formula:

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

0.089 = CN¥73m ÷ (CN¥1.0b - CN¥183m) (Based on the trailing twelve months to June 2022).

Thus, Road Environment Technology.Ltd has an ROCE of 8.9%. On its own that's a low return, but compared to the average of 6.7% generated by the Commercial Services industry, it's much better.

View our latest analysis for Road Environment Technology.Ltd

In the above chart we have measured Road Environment Technology.Ltd's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Road Environment Technology.Ltd here for free.

The Trend Of ROCE

We weren't thrilled with the trend because Road Environment Technology.Ltd's ROCE has reduced by 49% over the last five years, while the business employed 232% more capital. That being said, Road Environment Technology.Ltd raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Road Environment Technology.Ltd probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt. It's also worth noting the company's latest EBIT figure is within 10% of the previous year, so it's fair to assign the ROCE drop largely to the capital raise.

On a side note, Road Environment Technology.Ltd has done well to pay down its current liabilities to 18% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On Road Environment Technology.Ltd's ROCE

While returns have fallen for Road Environment Technology.Ltd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 34% to shareholders over the last year. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Road Environment Technology.Ltd does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...

While Road Environment Technology.Ltd may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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.