Hydrofarm Holdings Group (NASDAQ:HYFM) Might Have The Makings Of A Multi-Bagger

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Hydrofarm Holdings Group (NASDAQ:HYFM) looks quite promising in regards to its trends of return on capital.

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. The formula for this calculation on Hydrofarm Holdings Group is:

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

0.035 = US$23m ÷ (US$783m - US$119m) (Based on the trailing twelve months to September 2021).

Therefore, Hydrofarm Holdings Group has an ROCE of 3.5%. Ultimately, that's a low return and it under-performs the Machinery industry average of 10%.

Check out our latest analysis for Hydrofarm Holdings Group

In the above chart we have measured Hydrofarm Holdings Group's 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 Hydrofarm Holdings Group here for free.

What Can We Tell From Hydrofarm Holdings Group's ROCE Trend?

We're delighted to see that Hydrofarm Holdings Group is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses four years ago, but now it's earning 3.5% which is a sight for sore eyes. Not only that, but the company is utilizing 1,271% more capital than before, but that's to be expected from a company trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a related note, the company's ratio of current liabilities to total assets has decreased to 15%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business' underlying economics, which is great to see.

In Conclusion...

Overall, Hydrofarm Holdings Group gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Astute investors may have an opportunity here because the stock has declined 59% in the last year. So researching this company further and determining whether or not these trends will continue seems justified.

If you'd like to know about the risks facing Hydrofarm Holdings Group, we've discovered 3 warning signs that you should be aware of.

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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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.