HMS Hydraulic Machines & Systems Group (LON:HMSG) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at HMS Hydraulic Machines & Systems Group (LON:HMSG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. Analysts use this formula to calculate it for HMS Hydraulic Machines & Systems Group:

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

0.097 = ₽3.7b ÷ (₽65b - ₽26b) (Based on the trailing twelve months to December 2021).

Therefore, HMS Hydraulic Machines & Systems Group has an ROCE of 9.7%. On its own, that's a low figure but it's around the 11% average generated by the Machinery industry.

Check out our latest analysis for HMS Hydraulic Machines & Systems Group

In the above chart we have measured HMS Hydraulic Machines & Systems Group's 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 HMS Hydraulic Machines & Systems Group here for free.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at HMS Hydraulic Machines & Systems Group doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 9.7%. 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 separate but related note, it's important to know that HMS Hydraulic Machines & Systems Group has a current liabilities to total assets ratio of 41%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that HMS Hydraulic Machines & Systems Group is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 39% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

HMS Hydraulic Machines & Systems Group does have some risks, we noticed 5 warning signs (and 3 which are concerning) we think you should know about.

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

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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.