If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So on that note, Shanghai Challenge TextileLtd (SZSE:002486) looks quite promising in regards to its trends of return on capital.
What Is Return On Capital Employed (ROCE)?
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. To calculate this metric for Shanghai Challenge TextileLtd, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = CN¥60m ÷ (CN¥1.3b - CN¥180m) (Based on the trailing twelve months to September 2023).
Therefore, Shanghai Challenge TextileLtd has an ROCE of 5.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.1%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Shanghai Challenge TextileLtd, check out these free graphs here.
So How Is Shanghai Challenge TextileLtd's ROCE Trending?
We're delighted to see that Shanghai Challenge TextileLtd is reaping rewards from its investments and has now broken into profitability. The company now earns 5.5% on its capital, because five years ago it was incurring losses. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.
The Bottom Line On Shanghai Challenge TextileLtd's ROCE
As discussed above, Shanghai Challenge TextileLtd appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Given the stock has declined 36% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
While Shanghai Challenge TextileLtd looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether 002486 is currently trading for a fair price.
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.