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. 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. However, after briefly looking over the numbers, we don't think Burberry Group (LON:BRBY) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its 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)
0.11 = UK£285m ÷ (UK£3.6b - UK£1.0b) (Based on the trailing twelve months to September 2020).
Therefore, Burberry Group has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 8.1% it's much better.
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'd like, you can check out the forecasts from the analysts covering Burberry Group here for free.
What Can We Tell From Burberry Group's ROCE Trend?
On the surface, the trend of ROCE at Burberry Group doesn't inspire confidence. Over the last five years, returns on capital have decreased to 11% from 28% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. 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.
Our Take On Burberry Group's ROCE
In summary, we're somewhat concerned by Burberry Group's diminishing returns on increasing amounts of capital. However the stock has delivered a 64% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
On a final note, we've found 3 warning signs for Burberry Group that we think you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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