What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Guangdong Investment (HKG:270), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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. The formula for this calculation on Guangdong Investment is:

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

0.061 = HK$6.2b ÷ (HK$143b - HK$43b) (Based on the trailing twelve months to June 2023).

So, Guangdong Investment has an ROCE of 6.1%. Even though it's in line with the industry average of 6.3%, it's still a low return by itself.

View our latest analysis for Guangdong Investment

Above you can see how the current ROCE for Guangdong Investment compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Guangdong Investment here for free.

The Trend Of ROCE

When we looked at the ROCE trend at Guangdong Investment, we didn't gain much confidence. Around five years ago the returns on capital were 9.5%, but since then they've fallen to 6.1%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. 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 side note, Guangdong Investment's current liabilities have increased over the last five years to 30% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 6.1%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

In summary, we're somewhat concerned by Guangdong Investment's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 43% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

Guangdong Investment does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is a bit concerning...

While Guangdong Investment 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.