Hydrofarm Holdings Group (NASDAQ:HYFM) Is Reinvesting At Lower Rates Of Return
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after briefly looking over the numbers, we don't think Hydrofarm Holdings Group (NASDAQ:HYFM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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. Analysts use this formula to calculate it for Hydrofarm Holdings Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.026 = US$21m ÷ (US$891m - US$88m) (Based on the trailing twelve months to December 2021).
So, Hydrofarm Holdings Group has an ROCE of 2.6%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 10%.
Check out our latest analysis for Hydrofarm Holdings Group
Above you can see how the current ROCE for Hydrofarm Holdings 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 Hydrofarm Holdings Group.
What Can We Tell From Hydrofarm Holdings Group's ROCE Trend?
On the surface, the trend of ROCE at Hydrofarm Holdings Group doesn't inspire confidence. Around five years ago the returns on capital were 25%, but since then they've fallen to 2.6%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, Hydrofarm Holdings Group has decreased its current liabilities to 9.9% of total assets. So we could link some of this to the decrease in ROCE. 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.
What We Can Learn From Hydrofarm Holdings Group's ROCE
While returns have fallen for Hydrofarm Holdings Group in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Despite these promising trends, the stock has collapsed 74% over the last year, so there could be other factors hurting the company's prospects. Regardless, reinvestment can pay off in the long run, so we think astute investors may want to look further into this stock.
Like most companies, Hydrofarm Holdings Group does come with some risks, and we've found 3 warning signs that you should be aware of.
While Hydrofarm Holdings 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.
