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. Speaking of which, we noticed some great changes in ZTE's (SZSE:000063) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for ZTE:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.081 = CN¥9.3b ÷ (CN¥189b - CN¥74b) (Based on the trailing twelve months to September 2023).
Therefore, ZTE has an ROCE of 8.1%. On its own that's a low return, but compared to the average of 5.2% generated by the Communications industry, it's much better.
Check out our latest analysis for ZTE
Above you can see how the current ROCE for ZTE compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is ZTE's ROCE Trending?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 8.1%. The amount of capital employed has increased too, by 164%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 39%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that ZTE has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
In Conclusion...
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what ZTE has. Considering the stock has delivered 37% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. So with that in mind, we think the stock deserves further research.
One more thing to note, we've identified 1 warning sign with ZTE and understanding it should be part of your investment process.
While ZTE 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.