To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Three Squirrels (SZSE:300783) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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. Analysts use this formula to calculate it for Three Squirrels:

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

0.078 = CN¥242m ÷ (CN¥4.8b - CN¥1.7b) (Based on the trailing twelve months to March 2024).

So, Three Squirrels has an ROCE of 7.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.2%.

Above you can see how the current ROCE for Three Squirrels 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 Three Squirrels for free.

What Can We Tell From Three Squirrels' ROCE Trend?

When we looked at the ROCE trend at Three Squirrels, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 7.8% from 21% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

What We Can Learn From Three Squirrels' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Three Squirrels is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 56% over the last three years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a separate note, we've found 2 warning signs for Three Squirrels you'll probably want to 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.