Capital Allocation Trends At Hello Group (NASDAQ:MOMO) Aren't Ideal

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Having said that, from a first glance at Hello Group (NASDAQ:MOMO) 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. To calculate this metric for Hello Group, this is the formula:

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

0.15 = CN¥1.6b ÷ (CN¥15b - CN¥4.7b) (Based on the trailing twelve months to September 2022).

Thus, Hello Group has an ROCE of 15%. On its own, that's a standard return, however it's much better than the 5.2% generated by the Interactive Media and Services industry.

See our latest analysis for Hello Group

In the above chart we have measured Hello Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Hello Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 37% 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.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 30%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 15%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

We're a bit apprehensive about Hello Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Long term shareholders who've owned the stock over the last five years have experienced a 56% depreciation in their investment, so it appears the market might not like these trends either. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

If you'd like to know more about Hello Group, we've spotted 2 warning signs, and 1 of them is potentially serious.

While Hello Group may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.