Tencent Holdings (HKG:700) May Have Issues Allocating Its Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Tencent Holdings (HKG:700) and its ROCE trend, we weren't exactly thrilled.

What Is 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)

0.088 = CN¥102b ÷ (CN¥1.5t - CN¥300b) (Based on the trailing twelve months to June 2022).

Thus, Tencent Holdings has an ROCE of 8.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.8%.

Our analysis indicates that 700 is potentially overvalued!

Above you can see how the current ROCE for Tencent Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report 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 8.8%. However it looks like Tencent Holdings might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

The Key Takeaway

To conclude, we've found that Tencent Holdings is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 35% in the last five years. Therefore based on the analysis done in this article, we don't think Tencent Holdings has the makings of a multi-bagger.

Like most companies, Tencent Holdings does come with some risks, and we've found 1 warning sign that 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.