Kaufman & Broad's (EPA:KOF) Returns Have Hit A Wall

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 Kaufman & Broad (EPA:KOF), we aren't jumping out of our chairs because returns are decreasing.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Kaufman & Broad, this is the formula:

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

0.24 = €121m ÷ (€1.6b - €1.1b) (Based on the trailing twelve months to August 2023).

Therefore, Kaufman & Broad has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Consumer Durables industry average of 13%.

See our latest analysis for Kaufman & Broad

Above you can see how the current ROCE for Kaufman & Broad 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 Kaufman & Broad here for free.

The Trend Of ROCE

Over the past five years, Kaufman & Broad's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So while the current operations are delivering respectable returns, unless capital employed increases we'd be hard-pressed to believe it's a multi-bagger going forward. On top of that you'll notice that Kaufman & Broad has been paying out a large portion (90%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 70% of total assets, this reported ROCE would probably be less than24% because total capital employed would be higher.The 24% ROCE could be even lower if current liabilities weren't 70% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

Our Take On Kaufman & Broad's ROCE

In summary, Kaufman & Broad isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Unsurprisingly, the stock has only gained 12% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

If you want to know some of the risks facing Kaufman & Broad we've found 2 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

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. 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.