If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Having said that, from a first glance at Shanghai Moons' Electric (SHSE:603728) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Shanghai Moons' Electric is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = CN¥199m ÷ (CN¥3.9b - CN¥976m) (Based on the trailing twelve months to September 2023).
Therefore, Shanghai Moons' Electric has an ROCE of 6.9%. In absolute terms, that's a low return but it's around the Electrical industry average of 6.5%.
Above you can see how the current ROCE for Shanghai Moons' Electric compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Shanghai Moons' Electric for free.
What Can We Tell From Shanghai Moons' Electric's ROCE Trend?
On the surface, the trend of ROCE at Shanghai Moons' Electric doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.9% from 8.9% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.
Our Take On Shanghai Moons' Electric's ROCE
To conclude, we've found that Shanghai Moons' Electric is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 390% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a final note, we've found 1 warning sign for Shanghai Moons' Electric that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.