Neinor Homes (BME:HOME) May Have Issues Allocating Its Capital

Did you know there are some financial metrics that can provide clues of a potential 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. 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, from a first glance at Neinor Homes (BME:HOME) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is 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. The formula for this calculation on Neinor Homes is:

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

0.077 = €89m ÷ (€1.7b - €494m) (Based on the trailing twelve months to June 2024).

Thus, Neinor Homes has an ROCE of 7.7%. In absolute terms, that's a low return but it's around the Consumer Durables industry average of 9.1%.

View our latest analysis for Neinor Homes

In the above chart we have measured Neinor Homes' 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 Neinor Homes .

What Can We Tell From Neinor Homes' ROCE Trend?

On the surface, the trend of ROCE at Neinor Homes doesn't inspire confidence. To be more specific, ROCE has fallen from 9.7% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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.

On a side note, Neinor Homes has done well to pay down its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Neinor Homes' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 94% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

Neinor Homes does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those can't be ignored...

While Neinor Homes may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.