If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Huafon Chemical (SZSE:002064) 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)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Huafon Chemical:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.084 = CN¥2.2b ÷ (CN¥37b - CN¥11b) (Based on the trailing twelve months to September 2023).
Thus, Huafon Chemical has an ROCE of 8.4%. In absolute terms, that's a low return, but it's much better than the Chemicals industry average of 5.5%.
See our latest analysis for Huafon Chemical
In the above chart we have measured Huafon Chemical's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From Huafon Chemical's ROCE Trend?
In terms of Huafon Chemical's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 12%, but since then they've fallen to 8.4%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Key Takeaway
To conclude, we've found that Huafon Chemical 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 69% over the last five 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.
If you want to know some of the risks facing Huafon Chemical we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.
While Huafon Chemical 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.