If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, while the ROCE is currently high for Howden Joinery Group (LON:HWDN), we aren't jumping out of our chairs because returns are decreasing.
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. To calculate this metric for Howden Joinery Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = UK£427m ÷ (UK£2.0b - UK£503m) (Based on the trailing twelve months to June 2022).
So, Howden Joinery Group has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Trade Distributors industry average of 12%.
Above you can see how the current ROCE for Howden Joinery 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 Howden Joinery Group here for free.
So How Is Howden Joinery Group's ROCE Trending?
When we looked at the ROCE trend at Howden Joinery Group, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 44%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Howden Joinery Group has done well to pay down its current liabilities to 25% 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.
The Key Takeaway
In summary, despite lower returns in the short term, we're encouraged to see that Howden Joinery Group is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 48% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for Howden Joinery Group (of which 1 is significant!) that you should know about.
High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.
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