Burberry Group (LON:BRBY) Could Be Struggling To Allocate Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Burberry Group (LON:BRBY), we aren't jumping out of our chairs because returns are decreasing.

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 Burberry Group, this is the formula:

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

0.20 = UK£565m ÷ (UK£3.7b - UK£857m) (Based on the trailing twelve months to October 2022).

So, Burberry Group has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

View our latest analysis for Burberry Group

In the above chart we have measured Burberry 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.

SWOT Analysis for Burberry Group

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Burberry Group, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 32% 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. If these investments prove successful, this can bode very well for long term stock performance.

The Bottom Line

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Burberry Group. In light of this, the stock has only gained 39% over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

One more thing, we've spotted 1 warning sign facing Burberry Group that you might find interesting.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.