There Are Reasons To Feel Uneasy About H & M Hennes & Mauritz's (STO:HM B) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 investigating H & M Hennes & Mauritz (STO:HM B), we don't think it's current trends fit the mold of a multi-bagger.

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 H & M Hennes & Mauritz is:

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

0.11 = kr13b ÷ (kr192b - kr77b) (Based on the trailing twelve months to August 2022).

So, H & M Hennes & Mauritz has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 10% generated by the Specialty Retail industry.

View our latest analysis for H & M Hennes & Mauritz

In the above chart we have measured H & M Hennes & Mauritz'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 The Trend Of ROCE Can Tell Us

In terms of H & M Hennes & Mauritz's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 11% from 38% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that H & M Hennes & Mauritz has a current liabilities to total assets ratio of 40%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On H & M Hennes & Mauritz's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that H & M Hennes & Mauritz is reinvesting for growth and has higher sales as a result. However, total returns to shareholders over the last five years have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

If you'd like to know about the risks facing H & M Hennes & Mauritz, we've discovered 1 warning sign that you should be aware of.

While H & M Hennes & Mauritz 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.