If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 investigating Zhe Jiang Headman MachineryLtd (SHSE:688577), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Zhe Jiang Headman MachineryLtd is:

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

0.032 = CN¥31m ÷ (CN¥1.3b - CN¥382m) (Based on the trailing twelve months to December 2023).

Thus, Zhe Jiang Headman MachineryLtd has an ROCE of 3.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 6.1%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Zhe Jiang Headman MachineryLtd's ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Zhe Jiang Headman MachineryLtd.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 25% five years ago, while capital employed has grown 235%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Zhe Jiang Headman MachineryLtd might not have received a full period of earnings contribution from it.

On a related note, Zhe Jiang Headman MachineryLtd has decreased its current liabilities to 29% 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 Zhe Jiang Headman MachineryLtd's ROCE

In summary, Zhe Jiang Headman MachineryLtd is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 75% 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.

If you'd like to know more about Zhe Jiang Headman MachineryLtd, we've spotted 3 warning signs, and 2 of them are significant.

While Zhe Jiang Headman MachineryLtd 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.