What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. However, after briefly looking over the numbers, we don't think Qingdao Sentury Tire (SZSE:002984) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on Qingdao Sentury Tire is:

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

0.092 = CN¥807m ÷ (CN¥10b - CN¥1.3b) (Based on the trailing twelve months to March 2022).

Thus, Qingdao Sentury Tire has an ROCE of 9.2%. In absolute terms, that's a low return, but it's much better than the Auto Components industry average of 5.8%.

Check out our latest analysis for Qingdao Sentury Tire

In the above chart we have measured Qingdao Sentury Tire'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 report for Qingdao Sentury Tire.

What The Trend Of ROCE Can Tell Us

In terms of Qingdao Sentury Tire's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 9.2% from 15% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, Qingdao Sentury Tire has done well to pay down its current liabilities to 13% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

What We Can Learn From Qingdao Sentury Tire's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Qingdao Sentury Tire. And there could be an opportunity here if other metrics look good too, because the stock has declined 14% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Qingdao Sentury Tire (of which 1 is a bit unpleasant!) that you should know about.

While Qingdao Sentury Tire 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.