Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. On that note, looking into Hello Group (NASDAQ:MOMO), we weren't too upbeat about how things were going.
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Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Hello Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = CN¥1.5b ÷ (CN¥18b - CN¥6.4b) (Based on the trailing twelve months to December 2024).
Therefore, Hello Group has an ROCE of 13%. In absolute terms, that's a satisfactory return, but compared to the Interactive Media and Services industry average of 7.4% it's much better.
View our latest analysis for Hello Group
Above you can see how the current ROCE for Hello Group 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 Hello Group for free.
We are a bit anxious about the trends of ROCE at Hello Group. To be more specific, today's ROCE was 18% five years ago but has since fallen to 13%. On top of that, the business is utilizing 40% less capital within its operations. The combination of lower ROCE and less capital employed can indicate that a business is likely to be facing some competitive headwinds or seeing an erosion to its moat. If these underlying trends continue, we wouldn't be too optimistic going forward.
On a side note, Hello Group's current liabilities have increased over the last five years to 35% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 13%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
In summary, it's unfortunate that Hello Group is shrinking its capital base and also generating lower returns. Investors haven't taken kindly to these developments, since the stock has declined 61% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Like most companies, Hello Group does come with some risks, and we've found 2 warning signs that you should be aware of.
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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