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. 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. With that in mind, we've noticed some promising trends at China Automotive Systems (NASDAQ:CAAS) so let's look a bit deeper.

What Is 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. To calculate this metric for China Automotive Systems, this is the formula:

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

0.11 = US$45m ÷ (US$829m - US$434m) (Based on the trailing twelve months to September 2024).

Thus, China Automotive Systems has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.

See our latest analysis for China Automotive Systems

Historical performance is a great place to start when researching a stock so above you can see the gauge for China Automotive Systems' ROCE against it's prior returns. If you'd like to look at how China Automotive Systems has performed in the past in other metrics, you can view this free graph of China Automotive Systems' past earnings, revenue and cash flow.

How Are Returns Trending?

We're delighted to see that China Automotive Systems is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it's now turned things around and is earning 11% on its capital. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. That being said, while an increase in efficiency is no doubt appealing, it'd be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.

Another thing to note, China Automotive Systems has a high ratio of current liabilities to total assets of 52%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

To sum it up, China Automotive Systems is collecting higher returns from the same amount of capital, and that's impressive. And with a respectable 51% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. Therefore, we think it would be worth your time to check if these trends are going to continue.

While China Automotive Systems looks impressive, no company is worth an infinite price. The intrinsic value infographic for CAAS helps visualize whether it is currently trading for a fair price.

While China Automotive Systems 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.

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.