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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. In light of that, when we looked at HealthEquity (NASDAQ:HQY) and its ROCE trend, we weren't exactly thrilled.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for HealthEquity, this is the formula:

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

0.053 = US$179m ÷ (US$3.5b - US$121m) (Based on the trailing twelve months to July 2024).

So, HealthEquity has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the Healthcare industry average of 10%.

In the above chart we have measured HealthEquity's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for HealthEquity .

What Can We Tell From HealthEquity's ROCE Trend?

In terms of HealthEquity's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 8.6%, but since then they've fallen to 5.3%. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that HealthEquity is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 52% to shareholders over the last five years. 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.

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

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.