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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at ADD Industry (Zhejiang) (SHSE:603089), it didn't seem to tick all of these boxes.
Understanding 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 ADD Industry (Zhejiang), this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.05 = CN¥87m ÷ (CN¥2.7b - CN¥945m) (Based on the trailing twelve months to September 2023).
So, ADD Industry (Zhejiang) has an ROCE of 5.0%. On its own, that's a low figure but it's around the 5.8% average generated by the Auto Components industry.
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 , check out these free graphs detailing revenue and cash flow performance of ADD Industry (Zhejiang).
What Does the ROCE Trend For ADD Industry (Zhejiang) Tell Us?
We weren't thrilled with the trend because ADD Industry (Zhejiang)'s ROCE has reduced by 42% over the last five years, while the business employed 132% more capital. That being said, ADD Industry (Zhejiang) raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence ADD Industry (Zhejiang) might not have received a full period of earnings contribution from it.
The Bottom Line
In summary, ADD Industry (Zhejiang) is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last five years has been flat. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for ADD Industry (Zhejiang) (of which 1 is a bit unpleasant!) that you should know about.
While ADD Industry (Zhejiang) isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.