To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 Shenzhen XFH TechnologyLtd (SZSE:300890) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What is it?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Shenzhen XFH TechnologyLtd:

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

0.13 = CN¥169m ÷ (CN¥2.5b - CN¥1.2b) (Based on the trailing twelve months to March 2022).

Therefore, Shenzhen XFH TechnologyLtd has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 8.4% generated by the Electrical industry.

View our latest analysis for Shenzhen XFH TechnologyLtd

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Shenzhen XFH TechnologyLtd, check out these free graphs here.

What Does the ROCE Trend For Shenzhen XFH TechnologyLtd Tell Us?

Unfortunately, the trend isn't great with ROCE falling from 19% five years ago, while capital employed has grown 325%. Usually this isn't ideal, but given Shenzhen XFH TechnologyLtd conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Shenzhen XFH TechnologyLtd 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 49%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 13%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.

What We Can Learn From Shenzhen XFH TechnologyLtd's ROCE

While returns have fallen for Shenzhen XFH TechnologyLtd in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. In light of this, the stock has only gained 5.8% over the last year. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One final note, you should learn about the 3 warning signs we've spotted with Shenzhen XFH TechnologyLtd (including 1 which is a bit concerning) .

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.