If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 investigating Shenzhen Gas (SHSE:601139), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Shenzhen Gas is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.09 = CN¥1.7b ÷ (CN¥40b - CN¥22b) (Based on the trailing twelve months to June 2023).
So, Shenzhen Gas has an ROCE of 9.0%. Even though it's in line with the industry average of 9.2%, it's still a low return by itself.
See our latest analysis for Shenzhen Gas
In the above chart we have measured Shenzhen Gas' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Shenzhen Gas here for free.
So How Is Shenzhen Gas' ROCE Trending?
In terms of Shenzhen Gas' historical ROCE trend, it doesn't exactly demand attention. Over the past five years, ROCE has remained relatively flat at around 9.0% and the business has deployed 43% more capital into its operations. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 54% of total assets, this reported ROCE would probably be less than9.0% because total capital employed would be higher.The 9.0% ROCE could be even lower if current liabilities weren't 54% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.
Our Take On Shenzhen Gas' ROCE
In conclusion, Shenzhen Gas has been investing more capital into the business, but returns on that capital haven't increased. Unsurprisingly, the stock has only gained 26% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.
On a separate note, we've found 2 warning signs for Shenzhen Gas you'll probably want to know about.
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.
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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.