Returns On Capital Signal Tricky Times Ahead For Berkeley Group Holdings (LON:BKG)

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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 Berkeley Group Holdings (LON:BKG), we don't think it's current trends fit the mold of a multi-bagger.

Understanding 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 Berkeley Group Holdings is:

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

0.11 = UK£508m ÷ (UK£6.6b - UK£2.0b) (Based on the trailing twelve months to April 2022).

Thus, Berkeley Group Holdings has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Durables industry average of 12%.

View our latest analysis for Berkeley Group Holdings

Above you can see how the current ROCE for Berkeley Group Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

In terms of Berkeley Group Holdings' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 11% from 29% 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 side note, Berkeley Group Holdings has done well to pay down its current liabilities to 30% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Berkeley Group Holdings' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 22% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Like most companies, Berkeley Group Holdings does come with some risks, and we've found 2 warning signs that you should be aware of.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.