Capital Allocation Trends At HELLA GmbH KGaA (ETR:HLE) Aren't Ideal

When researching a stock for investment, what can tell us that the company is in decline? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. In light of that, from a first glance at HELLA GmbH KGaA (ETR:HLE), we've spotted some signs that it could be struggling, so let's investigate.

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. Analysts use this formula to calculate it for HELLA GmbH KGaA:

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

0.093 = €435m ÷ (€7.6b - €2.9b) (Based on the trailing twelve months to March 2024).

Therefore, HELLA GmbH KGaA has an ROCE of 9.3%. On its own, that's a low figure but it's around the 8.4% average generated by the Auto Components industry.

Check out our latest analysis for HELLA GmbH KGaA

In the above chart we have measured HELLA GmbH KGaA's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for HELLA GmbH KGaA .

So How Is HELLA GmbH KGaA's ROCE Trending?

There is reason to be cautious about HELLA GmbH KGaA, given the returns are trending downwards. About five years ago, returns on capital were 15%, however they're now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect HELLA GmbH KGaA to turn into a multi-bagger.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 38%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 9.3%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

In summary, it's unfortunate that HELLA GmbH KGaA is generating lower returns from the same amount of capital. Since the stock has skyrocketed 146% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

One more thing to note, we've identified 1 warning sign with HELLA GmbH KGaA and understanding this should be part of your investment process.

While HELLA GmbH KGaA 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.

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.