To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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 briefly looking over the numbers, we don't think China Risun Group (HKG:1907) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What Is 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. The formula for this calculation on China Risun Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.038 = CN¥950m ÷ (CN¥53b - CN¥28b) (Based on the trailing twelve months to June 2023).
Thus, China Risun Group has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Chemicals industry average of 9.3%.
See our latest analysis for China Risun Group
Above you can see how the current ROCE for China Risun Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering China Risun Group here for free.
What The Trend Of ROCE Can Tell Us
In terms of China Risun Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 3.8% from 29% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, China Risun Group has done well to pay down its current liabilities to 52% of total assets. That could partly explain why the ROCE has dropped. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line
To conclude, we've found that China Risun Group is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 50% over the last three years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing: We've identified 3 warning signs with China Risun Group (at least 1 which shouldn't be ignored) , and understanding these would certainly be useful.
While China Risun Group 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.