There Are Reasons To Feel Uneasy About Hafary Holdings' (SGX:5VS) Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Hafary Holdings (SGX:5VS), we don't think it's current trends fit the mold of a multi-bagger.

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 Hafary Holdings:

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

0.025 = S$4.2m ÷ (S$225m - S$59m) (Based on the trailing twelve months to December 2020).

Thus, Hafary Holdings has an ROCE of 2.5%. In absolute terms, that's a low return, but it's much better than the Trade Distributors industry average of 1.8%.

View our latest analysis for Hafary Holdings

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hafary Holdings' ROCE against it's prior returns. If you're interested in investigating Hafary Holdings' past further, check out this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

On the surface, the trend of ROCE at Hafary Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 2.5% from 12% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Hafary Holdings has decreased its current liabilities to 26% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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 On Hafary Holdings' ROCE

We're a bit apprehensive about Hafary Holdings because despite more capital being deployed in the business, returns on that capital and sales have both fallen. In spite of that, the stock has delivered a 20% return to shareholders who held over the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 6 warning signs for Hafary Holdings (of which 2 can't be ignored!) that you should know about.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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