hGears (ETR:HGEA) May Have Issues Allocating Its Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. In light of that, when we looked at hGears (ETR:HGEA) and its ROCE trend, we weren't exactly thrilled.

Understanding 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 hGears is:

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

0.0017 = €207k ÷ (€157m - €38m) (Based on the trailing twelve months to December 2022).

Therefore, hGears has an ROCE of 0.2%. In absolute terms, that's a low return and it also under-performs the Auto Components industry average of 9.1%.

Check out our latest analysis for hGears

Above you can see how the current ROCE for hGears compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at hGears doesn't inspire confidence. To be more specific, ROCE has fallen from 9.6% over the last five years. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, hGears has done well to pay down its current liabilities to 24% 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. 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 hGears' ROCE

In summary, hGears is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 71% over the last year. Therefore based on the analysis done in this article, we don't think hGears has the makings of a multi-bagger.

hGears does have some risks though, and we've spotted 1 warning sign for hGears that you might be interested in.

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.