Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Dalipal Holdings (HKG:1921) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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 Dalipal Holdings, this is the formula:

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

0.13 = CN¥290m ÷ (CN¥4.2b - CN¥2.0b) (Based on the trailing twelve months to June 2023).

Therefore, Dalipal Holdings has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Energy Services industry average of 7.9% it's much better.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Dalipal Holdings' ROCE against it's prior returns. If you're interested in investigating Dalipal Holdings' past further, check out this free graph covering Dalipal Holdings' past earnings, revenue and cash flow.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Dalipal Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 13% from 32% five years ago. 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, Dalipal Holdings has done well to pay down its current liabilities to 48% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 48% is still pretty high, so those risks are still somewhat prevalent.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Dalipal Holdings' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 364% gain to shareholders who have held over the last three years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Dalipal Holdings does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...

While Dalipal Holdings 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.