Healthcare Services Group (NASDAQ:HCSG) May Have Issues Allocating Its Capital

When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. In light of that, from a first glance at Healthcare Services Group (NASDAQ:HCSG), we've spotted some signs that it could be struggling, so let's investigate.

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. The formula for this calculation on Healthcare Services Group is:

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

0.064 = US$35m ÷ (US$722m - US$182m) (Based on the trailing twelve months to September 2022).

Thus, Healthcare Services Group has an ROCE of 6.4%. In absolute terms, that's a low return and it also under-performs the Commercial Services industry average of 9.3%.

Our analysis indicates that HCSG is potentially undervalued!

Above you can see how the current ROCE for Healthcare Services Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Healthcare Services Group.

How Are Returns Trending?

There is reason to be cautious about Healthcare Services Group, given the returns are trending downwards. Unfortunately the returns on capital have diminished from the 26% that they were earning five years ago. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Healthcare Services Group becoming one if things continue as they have.

The Bottom Line On Healthcare Services Group's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. It should come as no surprise then that the stock has fallen 69% over the last five years, so it looks like investors are recognizing these changes. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

Healthcare Services Group does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

While Healthcare Services Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.