What trends should we look for it we want to identify stocks that can 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. 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 Jiangsu Hualan New Pharmaceutical MaterialLtd (SZSE:301093) 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. The formula for this calculation on Jiangsu Hualan New Pharmaceutical MaterialLtd is:

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

0.028 = CN¥68m ÷ (CN¥2.6b - CN¥157m) (Based on the trailing twelve months to March 2023).

Thus, Jiangsu Hualan New Pharmaceutical MaterialLtd has an ROCE of 2.8%. Ultimately, that's a low return and it under-performs the Medical Equipment industry average of 9.8%.

Check out our latest analysis for Jiangsu Hualan New Pharmaceutical MaterialLtd

Above you can see how the current ROCE for Jiangsu Hualan New Pharmaceutical MaterialLtd compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Jiangsu Hualan New Pharmaceutical MaterialLtd.

So How Is Jiangsu Hualan New Pharmaceutical MaterialLtd's ROCE Trending?

When we looked at the ROCE trend at Jiangsu Hualan New Pharmaceutical MaterialLtd, we didn't gain much confidence. To be more specific, ROCE has fallen from 42% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Jiangsu Hualan New Pharmaceutical MaterialLtd has decreased its current liabilities to 6.0% 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 Jiangsu Hualan New Pharmaceutical MaterialLtd's ROCE

In summary, we're somewhat concerned by Jiangsu Hualan New Pharmaceutical MaterialLtd's diminishing returns on increasing amounts of capital. And long term shareholders have watched their investments stay flat over the last year. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

If you want to continue researching Jiangsu Hualan New Pharmaceutical MaterialLtd, you might be interested to know about the 3 warning signs that our analysis has discovered.

While Jiangsu Hualan New Pharmaceutical MaterialLtd 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.