LH Group (HKG:1978) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think LH Group (HKG:1978) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. The formula for this calculation on LH Group is:

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

0.077 = HK$36m ÷ (HK$779m - HK$308m) (Based on the trailing twelve months to June 2022).

Thus, LH Group has an ROCE of 7.7%. On its own that's a low return, but compared to the average of 2.9% generated by the Hospitality industry, it's much better.

Check out our latest analysis for LH Group

Historical performance is a great place to start when researching a stock so above you can see the gauge for LH Group's ROCE against it's prior returns. If you'd like to look at how LH Group has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is LH Group's ROCE Trending?

When we looked at the ROCE trend at LH Group, we didn't gain much confidence. To be more specific, ROCE has fallen from 20% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

Our Take On LH Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that LH Group is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 226% return over the last three years, so long term investors are no doubt ecstatic with that result. 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.

If you want to continue researching LH Group, you might be interested to know about the 2 warning signs that our analysis has discovered.

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.