Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Howden Joinery Group (LON:HWDN), we don't think it's current trends fit the mold of a multi-bagger.
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. To calculate this metric for Howden Joinery Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£172m ÷ (UK£1.4b - UK£302m) (Based on the trailing twelve months to June 2020).
Thus, Howden Joinery Group has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Trade Distributors industry average of 12% it's much better.
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 The Trend Of ROCE Can Tell Us
On the surface, the trend of ROCE at Howden Joinery Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 15% from 45% five years ago. 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.
On a related note, Howden Joinery Group has decreased its current liabilities to 21% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On Howden Joinery Group's ROCE
Bringing it all together, while we're somewhat encouraged by Howden Joinery Group's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 62% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Howden Joinery Group could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
While Howden Joinery Group 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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Howden Joinery Group
Howden Joinery Group Plc, a trade kitchen supplier, provides various products across kitchens, joinery, and hardware in the United Kingdom, France, and Belgium.
Outstanding track record with flawless balance sheet and pays a dividend.