The Returns On Capital At Tencent Holdings (HKG:700) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after briefly looking over the numbers, we don't think Tencent Holdings (HKG:700) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

Understanding 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 Tencent Holdings:

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

0.085 = CN¥101b ÷ (CN¥1.5t - CN¥285b) (Based on the trailing twelve months to September 2022).

Therefore, Tencent Holdings has an ROCE of 8.5%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.1%.

Check out 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.

So How Is Tencent Holdings' ROCE Trending?

When we looked at the ROCE trend at Tencent Holdings, we didn't gain much confidence. To be more specific, ROCE has fallen from 18% over the last five years. 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.

Our Take On Tencent Holdings' ROCE

Bringing it all together, while we're somewhat encouraged by Tencent Holdings' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last five years has been flat. 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.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.