Investors Could Be Concerned With Tencent Holdings' (HKG:700) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Tencent Holdings (HKG:700) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Tencent Holdings is:

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

0.079 = CN¥91b ÷ (CN¥1.6t - CN¥434b) (Based on the trailing twelve months to December 2022).

Thus, Tencent Holdings has an ROCE of 7.9%. On its own that's a low return, but compared to the average of 4.7% generated by the Interactive Media and Services industry, it's much better.

View our latest analysis for Tencent Holdings

In the above chart we have measured Tencent Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Tencent Holdings here for free.

SWOT Analysis for Tencent Holdings

How Are Returns Trending?

In terms of Tencent Holdings' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 18%, but since then they've fallen to 7.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

In Conclusion...

In summary, Tencent Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 12% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

On a final note, we've found 1 warning sign for Tencent Holdings that we think you should be aware of.

While Tencent Holdings 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.