The Returns On Capital At Pennant Group (NASDAQ:PNTG) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Pennant Group (NASDAQ:PNTG) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Pennant Group:

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

0.052 = US$23m ÷ (US$508m - US$66m) (Based on the trailing twelve months to March 2023).

So, Pennant Group has an ROCE of 5.2%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 9.3%.

Check out our latest analysis for Pennant Group

In the above chart we have measured Pennant Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Pennant Group.

What Does the ROCE Trend For Pennant Group Tell Us?

In terms of Pennant Group's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 27%, but since then they've fallen to 5.2%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a related note, Pennant Group has decreased its current liabilities to 13% 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.

The Key Takeaway

Bringing it all together, while we're somewhat encouraged by Pennant Group's reinvestment in its own business, we're aware that returns are shrinking. And in the last three years, the stock has given away 37% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Pennant Group has the makings of a multi-bagger.

One more thing, we've spotted 3 warning signs facing Pennant Group that you might find interesting.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.