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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think De Rucci Healthy Sleep (SZSE:001323) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for De Rucci Healthy Sleep, this is the formula:

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

0.17 = CN¥760m ÷ (CN¥7.1b - CN¥2.5b) (Based on the trailing twelve months to September 2023).

Therefore, De Rucci Healthy Sleep has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 8.3% generated by the Consumer Durables industry.

In the above chart we have measured De Rucci Healthy Sleep'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 De Rucci Healthy Sleep for free.

How Are Returns Trending?

In terms of De Rucci Healthy Sleep's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 39% over the last four years. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a related note, De Rucci Healthy Sleep has decreased its current liabilities to 36% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

What We Can Learn From De Rucci Healthy Sleep's ROCE

We're a bit apprehensive about De Rucci Healthy Sleep because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors haven't taken kindly to these developments, since the stock has declined 22% from where it was year ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

While De Rucci Healthy Sleep doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation for 001323 on our platform.

While De Rucci Healthy Sleep 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.