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. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 Shandong Humon Smelting (SZSE:002237), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Shandong Humon Smelting is:

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

0.057 = CN¥875m ÷ (CN¥22b - CN¥6.6b) (Based on the trailing twelve months to December 2023).

Thus, Shandong Humon Smelting has an ROCE of 5.7%. On its own, that's a low figure but it's around the 6.6% average generated by the Metals and Mining industry.

Above you can see how the current ROCE for Shandong Humon Smelting compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Shandong Humon Smelting .

What Can We Tell From Shandong Humon Smelting's ROCE Trend?

On the surface, the trend of ROCE at Shandong Humon Smelting doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.7% from 15% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Shandong Humon Smelting has decreased its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Shandong Humon Smelting is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 17% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Shandong Humon Smelting (of which 1 is a bit unpleasant!) that you should know about.

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.