Dr. Hönle (ETR:HNL) Could Be Struggling To Allocate Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. However, after briefly looking over the numbers, we don't think Dr. Hönle (ETR:HNL) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. Analysts use this formula to calculate it for Dr. Hönle:

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

0.05 = €9.4m ÷ (€213m - €25m) (Based on the trailing twelve months to March 2021).

Therefore, Dr. Hönle has an ROCE of 5.0%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 12%.

View our latest analysis for Dr. Hönle

Above you can see how the current ROCE for Dr. Hönle compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Dr. Hönle.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Dr. Hönle, we didn't gain much confidence. Around five years ago the returns on capital were 16%, but since then they've fallen to 5.0%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Dr. Hönle's ROCE

To conclude, we've found that Dr. Hönle is reinvesting in the business, but returns have been falling. Yet to long term shareholders the stock has gifted them an incredible 131% return in the last five years, so the market appears to be rosy about its future. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

If you'd like to know more about Dr. Hönle, we've spotted 3 warning signs, and 1 of them is a bit unpleasant.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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