WH Group (HKG:288) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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. Although, when we looked at WH Group (HKG:288), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for WH Group:

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

0.085 = US$1.2b ÷ (US$20b - US$5.0b) (Based on the trailing twelve months to June 2021).

Thus, WH Group has an ROCE of 8.5%. Ultimately, that's a low return and it under-performs the Food industry average of 11%.

Check out our latest analysis for WH Group

In the above chart we have measured WH Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for WH Group.

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

When we looked at the ROCE trend at WH Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.5% from 17% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

Our Take On WH Group's ROCE

Bringing it all together, while we're somewhat encouraged by WH Group's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 3.3% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you'd like to know about the risks facing WH Group, we've discovered 3 warning signs that you should be aware of.

While WH 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.

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.

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