Returns On Capital Signal Tricky Times Ahead For Lynch Group Holdings (ASX:LGL)
Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Lynch Group Holdings (ASX:LGL) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Lynch Group Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = AU$13m ÷ (AU$395m - AU$68m) (Based on the trailing twelve months to January 2023).
Therefore, Lynch Group Holdings has an ROCE of 3.9%. In absolute terms, that's a low return, but it's much better than the Food industry average of 2.9%.
View our latest analysis for Lynch Group Holdings
Above you can see how the current ROCE for Lynch 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 Lynch Group Holdings.
What The Trend Of ROCE Can Tell Us
In terms of Lynch Group Holdings' historical ROCE movements, the trend isn't fantastic. Around two years ago the returns on capital were 15%, but since then they've fallen to 3.9%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a side note, Lynch Group Holdings has done well to pay down its current liabilities to 17% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In Conclusion...
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Lynch Group Holdings. However, despite the promising trends, the stock has fallen 27% over the last year, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
On a separate note, we've found 1 warning sign for Lynch Group Holdings you'll probably want to know about.
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.
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