Howden Joinery Group (LON:HWDN) Might Be Having Difficulty Using Its Capital Effectively

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Having said that, while the ROCE is currently high for Howden Joinery Group (LON:HWDN), we aren't jumping out of our chairs because returns are decreasing.

Return On Capital Employed (ROCE): What Is It?

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 Howden Joinery Group is:

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

0.29 = UK£427m ÷ (UK£2.0b - UK£503m) (Based on the trailing twelve months to June 2022).

So, Howden Joinery Group has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

Check out our latest analysis for Howden Joinery Group

In the above chart we have measured Howden Joinery Group's 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 Does the ROCE Trend For Howden Joinery Group Tell Us?

On the surface, the trend of ROCE at Howden Joinery Group doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 44%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a related note, Howden Joinery Group has decreased its current liabilities to 25% of total assets. So we could link some of this to the decrease in ROCE. 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.

What We Can Learn From Howden Joinery Group's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Howden Joinery Group is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 56% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One final note, you should learn about the 2 warning signs we've spotted with Howden Joinery Group (including 1 which is significant) .

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.