If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, 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 investigating Inner Mongolia ERDOS ResourcesLtd (SHSE:600295), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Inner Mongolia ERDOS ResourcesLtd is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = CN¥3.4b ÷ (CN¥49b - CN¥18b) (Based on the trailing twelve months to September 2023).

So, Inner Mongolia ERDOS ResourcesLtd has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 6.3% it's much better.

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're interested in investigating Inner Mongolia ERDOS ResourcesLtd's past further, check out this free graph of past earnings, revenue and cash flow.

What Does the ROCE Trend For Inner Mongolia ERDOS ResourcesLtd Tell Us?

In terms of Inner Mongolia ERDOS ResourcesLtd's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 19%, but since then they've fallen to 11%. 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.

On a side note, Inner Mongolia ERDOS ResourcesLtd has done well to pay down its current liabilities to 36% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

What We Can Learn From Inner Mongolia ERDOS ResourcesLtd's ROCE

We're a bit apprehensive about Inner Mongolia ERDOS ResourcesLtd because despite more capital being deployed in the business, returns on that capital and sales have both fallen. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 208%. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a final note, we've found 2 warning signs for Inner Mongolia ERDOS ResourcesLtd that we think you should be aware of.

While Inner Mongolia ERDOS ResourcesLtd 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.