To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Hongcheng Environmental Technology (HKG:2265) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Hongcheng Environmental Technology:

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

0.12 = CN¥79m ÷ (CN¥921m - CN¥248m) (Based on the trailing twelve months to December 2024).

So, Hongcheng Environmental Technology has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 6.7% generated by the Commercial Services industry.

View our latest analysis for Hongcheng Environmental Technology

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'd like to look at how Hongcheng Environmental Technology has performed in the past in other metrics, you can view this free graph of Hongcheng Environmental Technology's past earnings, revenue and cash flow.

What Does the ROCE Trend For Hongcheng Environmental Technology Tell Us?

When we looked at the ROCE trend at Hongcheng Environmental Technology, we didn't gain much confidence. To be more specific, ROCE has fallen from 29% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Hongcheng Environmental Technology has decreased its current liabilities to 27% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Hongcheng Environmental Technology's ROCE

While returns have fallen for Hongcheng Environmental Technology in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 57% to shareholders over the last three years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you want to continue researching Hongcheng Environmental Technology, you might be interested to know about the 1 warning sign that our analysis has discovered.

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.