What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at BHG Group (STO:BHG), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on BHG Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.063 = kr696m ÷ (kr14b - kr2.6b) (Based on the trailing twelve months to December 2021).
Thus, BHG Group has an ROCE of 6.3%. In absolute terms, that's a low return and it also under-performs the Online Retail industry average of 9.6%.
In the above chart we have measured BHG Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From BHG Group's ROCE Trend?
Unfortunately, the trend isn't great with ROCE falling from 22% five years ago, while capital employed has grown 2,070%. Usually this isn't ideal, but given BHG Group conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence BHG Group might not have received a full period of earnings contribution from it. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
On a side note, BHG Group has done well to pay down its current liabilities to 19% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line
While returns have fallen for BHG Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has followed suit returning a meaningful 58% to shareholders over the last three years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for BHG Group (of which 1 is significant!) that you should know about.
While BHG 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.
Valuation is complex, but we're helping make it simple.
Find out whether BHG Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.