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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Xiamen Leading Optics (SHSE:605118) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on Xiamen Leading Optics is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = CN¥113m ÷ (CN¥1.6b - CN¥113m) (Based on the trailing twelve months to September 2023).
So, Xiamen Leading Optics has an ROCE of 7.7%. On its own that's a low return, but compared to the average of 5.4% generated by the Electronic industry, it's much better.
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 Xiamen Leading Optics has performed in the past in other metrics, you can view this free graph of Xiamen Leading Optics' past earnings, revenue and cash flow.
So How Is Xiamen Leading Optics' ROCE Trending?
In terms of Xiamen Leading Optics' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 50%, but since then they've fallen to 7.7%. However it looks like Xiamen Leading Optics might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Xiamen Leading Optics has done well to pay down its current liabilities to 7.1% 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.
What We Can Learn From Xiamen Leading Optics' ROCE
To conclude, we've found that Xiamen Leading Optics is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 3.6% in the last three years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
On a final note, we found 3 warning signs for Xiamen Leading Optics (1 is a bit unpleasant) you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.