Some Investors May Be Worried About Berkeley Group Holdings' (LON:BKG) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Berkeley Group Holdings (LON:BKG), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its 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)

0.12 = UK£441m ÷ (UK£5.6b - UK£1.8b) (Based on the trailing twelve months to October 2020).

Thus, Berkeley Group Holdings has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 7.2% generated by the Consumer Durables industry.

See our latest analysis for Berkeley Group Holdings

In the above chart we have measured Berkeley Group Holdings' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Berkeley Group Holdings.

What Does the ROCE Trend For Berkeley Group Holdings Tell Us?

When we looked at the ROCE trend at Berkeley Group Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 12%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a related note, Berkeley Group Holdings has decreased its current liabilities to 32% of total assets. So we could link some of this to the decrease in ROCE. 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. 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

In summary, we're somewhat concerned by Berkeley Group Holdings' diminishing returns on increasing amounts of capital. But investors must be expecting an improvement of sorts because over the last five yearsthe stock has delivered a respectable 70% return. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

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

While Berkeley Group Holdings isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. 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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