If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Shanxi Huhua Group (SZSE:003002) 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?

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. Analysts use this formula to calculate it for Shanxi Huhua Group:

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

0.062 = CN¥77m ÷ (CN¥1.5b - CN¥297m) (Based on the trailing twelve months to December 2021).

So, Shanxi Huhua Group has an ROCE of 6.2%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.7%.

Check out our latest analysis for Shanxi Huhua Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for Shanxi Huhua Group's ROCE against it's prior returns. If you'd like to look at how Shanxi Huhua Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

The Trend Of ROCE

The returns on capital haven't changed much for Shanxi Huhua Group in recent years. The company has employed 127% more capital in the last five years, and the returns on that capital have remained stable at 6.2%. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.

What We Can Learn From Shanxi Huhua Group's ROCE

In summary, Shanxi Huhua Group has simply been reinvesting capital and generating the same low rate of return as before. Since the stock has gained an impressive 53% over the last year, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know about the risks facing Shanxi Huhua Group, we've discovered 3 warning signs that you should be aware of.

While Shanxi Huhua Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.