Under The Bonnet, Harvey Norman Holdings' (ASX:HVN) Returns Look Impressive

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. So when we looked at the ROCE trend of Harvey Norman Holdings (ASX:HVN) we really liked what we saw.

What is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Harvey Norman Holdings is:

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

0.20 = AU$1.0b ÷ (AU$6.3b - AU$1.1b) (Based on the trailing twelve months to December 2020).

Therefore, Harvey Norman Holdings has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 6.6% earned by companies in a similar industry.

View 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'd like, you can check out the forecasts from the analysts covering Harvey Norman Holdings here for free.

How Are Returns Trending?

The trends we've noticed at Harvey Norman Holdings are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 20%. Basically the business is earning more per dollar of capital invested and in addition to that, 67% more capital is being employed now too. 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.

On a related note, the company's ratio of current liabilities to total assets has decreased to 17%, which basically reduces it's funding from the likes of short-term creditors or suppliers. This tells us that Harvey Norman Holdings has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.

The Bottom Line

In summary, it's great to see that Harvey Norman Holdings can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 64% return over the last five years. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Harvey Norman Holdings does have some risks, we noticed 2 warning signs (and 1 which is significant) we think you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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This article by Simply Wall St is general in nature. 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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