What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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 Hilton Food Group (LON:HFG) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Hilton Food Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.096 = UK£54m ÷ (UK£978m - UK£411m) (Based on the trailing twelve months to July 2020).
Thus, Hilton Food Group has an ROCE of 9.6%. In absolute terms, that's a low return but it's around the Food industry average of 9.4%.
Above you can see how the current ROCE for Hilton Food 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 Hilton Food Group here for free.
What Can We Tell From Hilton Food Group's ROCE Trend?
On the surface, the trend of ROCE at Hilton Food Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 9.6% from 27% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.On a side note, Hilton Food Group has done well to pay down its current liabilities to 42% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 42% is still pretty high, so those risks are still somewhat prevalent.
In summary, despite lower returns in the short term, we're encouraged to see that Hilton Food Group is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 171% to shareholders in the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Like most companies, Hilton Food Group does come with some risks, and we've found 1 warning sign that you should be aware of.
While Hilton Food 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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