Grown Up Group Investment Holdings (HKG:1842) May Have Issues Allocating Its Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? A business that's potentially in decline often shows two trends, a return on capital employed (ROCE) that's declining, and a base of capital employed that's also declining. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Grown Up Group Investment Holdings (HKG:1842), we weren't too hopeful.

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. To calculate this metric for Grown Up Group Investment Holdings, this is the formula:

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

0.064 = HK$6.7m ÷ (HK$229m - HK$123m) (Based on the trailing twelve months to December 2021).

So, Grown Up Group Investment Holdings has an ROCE of 6.4%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 9.0%.

View our latest analysis for Grown Up Group Investment Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Grown Up Group Investment Holdings, check out these free graphs here.

The Trend Of ROCE

In terms of Grown Up Group Investment Holdings' historical ROCE trend, it isn't fantastic. The company used to generate 22% on its capital five years ago but it has since fallen noticeably. On top of that, the business is utilizing 25% less capital within its operations. When you see both ROCE and capital employed diminishing, it can often be a sign of a mature and shrinking business that might be in structural decline. Typically businesses that exhibit these characteristics aren't the ones that tend to multiply over the long term, because statistically speaking, they've already gone through the growth phase of their life cycle.

On a related note, Grown Up Group Investment Holdings has decreased its current liabilities to 54% 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. 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. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

Our Take On Grown Up Group Investment Holdings' ROCE

In summary, it's unfortunate that Grown Up Group Investment Holdings is shrinking its capital base and also generating lower returns. Yet despite these poor fundamentals, the stock has gained a huge 704% over the last year, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Grown Up Group Investment Holdings does have some risks, we noticed 3 warning signs (and 1 which makes us a bit uncomfortable) we think you should know about.

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.