To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 briefly looking over the numbers, we don't think China Railway Materials (SZSE:000927) 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)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for China Railway Materials:

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

0.13 = CN¥1.4b ÷ (CN¥34b - CN¥23b) (Based on the trailing twelve months to June 2022).

Therefore, China Railway Materials has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Auto industry average of 5.6% it's much better.

Check out our latest analysis for China Railway Materials

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you'd like to look at how China Railway Materials 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

When we looked at the ROCE trend at China Railway Materials, we didn't gain much confidence. To be more specific, ROCE has fallen from 17% over the last two years. 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 separate but related note, it's important to know that China Railway Materials has a current liabilities to total assets ratio of 69%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

While returns have fallen for China Railway Materials in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 23% over the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

One more thing to note, we've identified 1 warning sign with China Railway Materials and understanding it should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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.