To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Lingyi iTech (Guangdong) (SZSE:002600), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Lingyi iTech (Guangdong), this is the formula:

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

0.13 = CN¥3.2b ÷ (CN¥38b - CN¥14b) (Based on the trailing twelve months to September 2023).

Therefore, Lingyi iTech (Guangdong) has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 5.4% generated by the Electronic industry.

In the above chart we have measured Lingyi iTech (Guangdong)'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 Lingyi iTech (Guangdong) .

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 19% five years ago, while the business's capital employed increased by 115%. 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. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Lingyi iTech (Guangdong) might not have received a full period of earnings contribution from it.

On a side note, Lingyi iTech (Guangdong) has done well to pay down its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. 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.

Our Take On Lingyi iTech (Guangdong)'s ROCE

Bringing it all together, while we're somewhat encouraged by Lingyi iTech (Guangdong)'s reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 1.0% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing, we've spotted 1 warning sign facing Lingyi iTech (Guangdong) that you might find interesting.

While Lingyi iTech (Guangdong) 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.