iHuman (NYSE:IH) May Have Issues Allocating Its Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 iHuman (NYSE:IH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Return On Capital Employed (ROCE): What Is It?

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 iHuman is:

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

0.083 = CN¥62m ÷ (CN¥1.2b - CN¥482m) (Based on the trailing twelve months to September 2022).

Thus, iHuman has an ROCE of 8.3%. Even though it's in line with the industry average of 8.4%, it's still a low return by itself.

Check out the opportunities and risks within the US Entertainment industry.

Above you can see how the current ROCE for iHuman compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering iHuman here for free.

How Are Returns Trending?

On the surface, the trend of ROCE at iHuman doesn't inspire confidence. Over the last two years, returns on capital have decreased to 8.3% from 25% two years ago. However it looks like iHuman might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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, iHuman has decreased its current liabilities to 39% of total assets. That could partly explain why the ROCE has dropped. 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On iHuman's ROCE

Bringing it all together, while we're somewhat encouraged by iHuman's reinvestment in its own business, we're aware that returns are shrinking. And in the last year, the stock has given away 48% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

On a final note, we've found 2 warning signs for iHuman that we think you should be aware of.

While iHuman 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.