LH Group (HKG:1978) Will Want To Turn Around Its Return Trends

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at LH Group (HKG:1978) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for LH Group, this is the formula:

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

0.026 = HK$14m ÷ (HK$747m - HK$217m) (Based on the trailing twelve months to December 2020).

So, LH Group has an ROCE of 2.6%. In absolute terms, that's a low return, but it's much better than the Hospitality industry average of 2.0%.

See our latest analysis for LH Group

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 LH Group, check out these free graphs here.

What Can We Tell From LH Group's ROCE Trend?

On the surface, the trend of ROCE at LH Group doesn't inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, LH Group has done well to pay down its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On LH Group's ROCE

In summary, we're somewhat concerned by LH Group's diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last three yearsthe stock has delivered a respectable 46% return. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

One more thing, we've spotted 4 warning signs facing LH Group that you might find interesting.

While LH 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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