If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. So when we looked at Howden Joinery Group (LON:HWDN), they do have a high ROCE, but we weren't exactly elated from how returns are trending.
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. 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)
0.26 = UK£333m ÷ (UK£1.8b - UK£523m) (Based on the trailing twelve months to June 2021).
Therefore, Howden Joinery Group has an ROCE of 26%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
Above you can see how the current ROCE for Howden Joinery Group 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 Howden Joinery Group.
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. To be more specific, while the ROCE is still high, it's fallen from 52% where it was five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Howden Joinery Group. And long term investors must be optimistic going forward because the stock has returned a huge 173% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 1 warning sign facing Howden Joinery Group that you might find interesting.
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.
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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.