Returns On Capital At LH Group (HKG:1978) Have Stalled

There are a few key trends to look for if we want to identify the next 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at LH Group (HKG:1978) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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. The formula for this calculation on LH Group is:

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

0.13 = HK$50m ÷ (HK$692m - HK$320m) (Based on the trailing twelve months to June 2024).

Therefore, LH Group has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 6.9% it's much better.

Check out 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're interested in investigating LH Group's past further, check out this free graph covering LH Group's past earnings, revenue and cash flow.

The Trend Of ROCE

Over the past five years, LH Group's ROCE has remained relatively flat while the business is using 39% less capital than before. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. You could assume that if this continues, the business will be smaller in a few year time, so probably not a multi-bagger.

On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 46% of total assets, this reported ROCE would probably be less than13% because total capital employed would be higher.The 13% ROCE could be even lower if current liabilities weren't 46% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Bottom Line On LH Group's ROCE

It's a shame to see that LH Group is effectively shrinking in terms of its capital base. Although the market must be expecting these trends to improve because the stock has gained 45% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Like most companies, LH Group does come with some risks, and we've found 3 warning signs that you should be aware of.

While LH 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.