We're Watching These Trends At Hafary Holdings (SGX:5VS)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Hafary Holdings (SGX:5VS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the 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)

0.036 = S$5.7m ÷ (S$231m - S$72m) (Based on the trailing twelve months to June 2020).

So, Hafary Holdings has an ROCE of 3.6%. In absolute terms, that's a low return and it also under-performs the Trade Distributors industry average of 5.0%.

Check out 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'd like to look at how Hafary Holdings has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

How Are Returns Trending?

When we looked at the ROCE trend at Hafary Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 21%, but since then they've fallen to 3.6%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, Hafary Holdings has done well to pay down its current liabilities to 31% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take 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. Despite the concerning underlying trends, the stock has actually gained 2.0% over the last five years, so it might be that the investors are expecting the trends to reverse. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.

One more thing: We've identified 5 warning signs with Hafary Holdings (at least 2 which can't be ignored) , and understanding these would certainly be useful.

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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