Be Wary Of Lynch Group Holdings (ASX:LGL) And Its Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Lynch Group Holdings (ASX:LGL) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Lynch Group Holdings is:

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

0.073 = AU$24m ÷ (AU$395m - AU$71m) (Based on the trailing twelve months to December 2021).

So, Lynch Group Holdings has an ROCE of 7.3%. Even though it's in line with the industry average of 6.6%, it's still a low return by itself.

View our latest analysis for Lynch Group Holdings

In the above chart we have measured Lynch Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lynch Group Holdings here for free.

So How Is Lynch Group Holdings' ROCE Trending?

When we looked at the ROCE trend at Lynch Group Holdings, we didn't gain much confidence. Around one year ago the returns on capital were 16%, but since then they've fallen to 7.3%. 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, Lynch Group Holdings has decreased its current liabilities to 18% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

In Conclusion...

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Lynch Group Holdings. However, despite the promising trends, the stock has fallen 28% over the last year, so there might be an opportunity here for astute investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing to note, we've identified 3 warning signs with Lynch Group Holdings and understanding these should be part of your investment process.

While Lynch Group Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.