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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Zhejiang Changhua Auto Parts (SHSE:605018), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Zhejiang Changhua Auto Parts:

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

0.038 = CN¥109m ÷ (CN¥3.4b - CN¥521m) (Based on the trailing twelve months to March 2022).

Therefore, Zhejiang Changhua Auto Parts has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 5.6%.

See our latest analysis for Zhejiang Changhua Auto Parts

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'd like to look at how Zhejiang Changhua Auto Parts has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 24% five years ago, while capital employed has grown 212%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Zhejiang Changhua Auto Parts 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.

On a related note, Zhejiang Changhua Auto Parts has decreased its current liabilities to 15% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

The Key Takeaway

In summary, Zhejiang Changhua Auto Parts is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 9.1% over the last year. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

One final note, you should learn about the 4 warning signs we've spotted with Zhejiang Changhua Auto Parts (including 1 which is a bit unpleasant) .

While Zhejiang Changhua Auto Parts 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.