To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Although, when we looked at Pony Testing (SZSE:300887), it didn't seem to tick all of these boxes.
What Is Return On Capital Employed (ROCE)?
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. To calculate this metric for Pony Testing, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.078 = CN¥282m ÷ (CN¥4.3b - CN¥709m) (Based on the trailing twelve months to September 2023).
Thus, Pony Testing has an ROCE of 7.8%. On its own that's a low return, but compared to the average of 5.5% generated by the Professional Services industry, it's much better.
Check out our latest analysis for Pony Testing
Above you can see how the current ROCE for Pony Testing 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 Pony Testing.
How Are Returns Trending?
In terms of Pony Testing's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 15%, but since then they've fallen to 7.8%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
Our Take On Pony Testing's ROCE
In summary, we're somewhat concerned by Pony Testing's diminishing returns on increasing amounts of capital. Investors haven't taken kindly to these developments, since the stock has declined 14% from where it was three years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a separate note, we've found 1 warning sign for Pony Testing you'll probably want to know about.
While Pony Testing 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.