Here's What's Concerning About Arrow Home Group's (SZSE:001322) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Arrow Home Group (SZSE:001322) 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?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Arrow Home Group, this is the formula:

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

0.063 = CN¥388m ÷ (CN¥9.6b - CN¥3.5b) (Based on the trailing twelve months to March 2024).

Therefore, Arrow Home Group has an ROCE of 6.3%. On its own, that's a low figure but it's around the 7.7% average generated by the Building industry.

Check out our latest analysis for Arrow Home Group

Above you can see how the current ROCE for Arrow Home Group 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 Arrow Home Group for free.

What The Trend Of ROCE Can Tell Us

In terms of Arrow Home Group's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 6.3% from 20% 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. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Arrow Home Group has decreased its current liabilities to 36% 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.

Our Take On Arrow Home Group's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Arrow Home Group. And there could be an opportunity here if other metrics look good too, because the stock has declined 42% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

On a separate note, we've found 2 warning signs for Arrow Home Group you'll probably want to know about.

While Arrow Home Group 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.

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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.