Harvey Norman Holdings (ASX:HVN) Knows How To Allocate Capital Effectively

There are a few key trends to look for if we want to identify the next 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Harvey Norman Holdings (ASX:HVN) looks great, so lets see what the trend can tell us.

Return On Capital Employed (ROCE): What is it?

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 Harvey Norman Holdings, this is the formula:

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

0.20 = AU$1.1b ÷ (AU$6.7b - AU$1.1b) (Based on the trailing twelve months to June 2021).

Thus, Harvey Norman Holdings has an ROCE of 20%. While that is an outstanding return, the rest of the Multiline Retail industry generates similar returns, on average.

See our latest analysis for Harvey Norman Holdings

In the above chart we have measured Harvey Norman Holdings' 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 report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

We like the trends that we're seeing from Harvey Norman Holdings. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 20%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 75%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 17%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.

Our Take On Harvey Norman Holdings' ROCE

All in all, it's terrific to see that Harvey Norman Holdings is reaping the rewards from prior investments and is growing its capital base. And with a respectable 44% awarded to those who held the stock over the last five years, you could argue that these developments are starting to get the attention they deserve. In light of that, we think it's worth looking further into this stock because if Harvey Norman Holdings can keep these trends up, it could have a bright future ahead.

On a final note, we found 2 warning signs for Harvey Norman Holdings (1 is significant) you should be aware of.

Harvey Norman Holdings is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.