Life Healthcare Group Holdings (JSE:LHC) Could Be Struggling To Allocate Capital

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. Having said that, from a first glance at Life Healthcare Group Holdings (JSE:LHC) 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 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. The formula for this calculation on Life Healthcare Group Holdings is:

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

0.078 = R2.7b ÷ (R42b - R7.6b) (Based on the trailing twelve months to September 2022).

Therefore, Life Healthcare Group Holdings has an ROCE of 7.8%. In absolute terms, that's a low return and it also under-performs the Healthcare industry average of 15%.

View our latest analysis for Life Healthcare Group Holdings

Above you can see how the current ROCE for Life Healthcare Group Holdings 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 Life Healthcare Group Holdings.

What Does the ROCE Trend For Life Healthcare Group Holdings Tell Us?

In terms of Life Healthcare Group Holdings' historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 14% over the last five years. However it looks like Life Healthcare Group Holdings 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 may take some time before the company starts to see any change in earnings from these investments.

On a side note, Life Healthcare Group Holdings has done well to pay down its current liabilities to 18% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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 Life Healthcare Group Holdings' ROCE

To conclude, we've found that Life Healthcare Group Holdings is reinvesting in the business, but returns have been falling. And investors appear hesitant that the trends will pick up because the stock has fallen 22% in the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

One more thing to note, we've identified 1 warning sign with Life Healthcare Group Holdings and understanding this should be part of your investment process.

While Life Healthcare Group Holdings 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.