Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Grown Up Group Investment Holdings (HKG:1842), it didn't seem to tick all of these boxes.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Grown Up Group Investment Holdings is:

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

0.0028 = HK$388k ÷ (HK$276m - HK$138m) (Based on the trailing twelve months to December 2022).

Thus, Grown Up Group Investment Holdings has an ROCE of 0.3%. Ultimately, that's a low return and it under-performs the Luxury industry average of 11%.

See our latest analysis for Grown Up Group Investment Holdings

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Grown Up Group Investment Holdings, check out these free graphs here.

How Are Returns Trending?

We weren't thrilled with the trend because Grown Up Group Investment Holdings' ROCE has reduced by 99% over the last five years, while the business employed 48% more capital. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Grown Up Group Investment Holdings might not have received a full period of earnings contribution from it.

On a side note, Grown Up Group Investment Holdings has done well to pay down its current liabilities to 50% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Keep in mind 50% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From Grown Up Group Investment Holdings' ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Grown Up Group Investment Holdings. Furthermore the stock has climbed 71% over the last three years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Grown Up Group Investment Holdings does have some risks, we noticed 4 warning signs (and 2 which are potentially serious) we think you should know about.

While Grown Up Group Investment Holdings 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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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.