To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. In light of that, when we looked at China Everbright Environment Group (HKG:257) and its ROCE trend, we weren't exactly thrilled.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for China Everbright Environment Group, this is the formula:

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

0.075 = HK$11b ÷ (HK$189b - HK$41b) (Based on the trailing twelve months to December 2023).

So, China Everbright Environment Group has an ROCE of 7.5%. On its own, that's a low figure but it's around the 7.2% average generated by the Commercial Services industry.

In the above chart we have measured China Everbright Environment Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for China Everbright Environment Group .

How Are Returns Trending?

In terms of China Everbright Environment Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 7.5% from 10% five years ago. 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.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for China Everbright Environment Group have fallen, meanwhile the business is employing more capital than it was five years ago. Investors haven't taken kindly to these developments, since the stock has declined 45% from where it was five years ago. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One more thing: We've identified 2 warning signs with China Everbright Environment Group (at least 1 which can't be ignored) , and understanding them would certainly be useful.

While China Everbright Environment Group 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.

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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.