Diageo (LON:DGE) Has More To Do To Multiply In Value Going Forward

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 Diageo (LON:DGE), it didn't seem to tick all of these boxes.

What is 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 Diageo is:

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

0.15 = UK£3.8b ÷ (UK£32b - UK£7.1b) (Based on the trailing twelve months to June 2021).

Thus, Diageo has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Beverage industry average of 14%.

See our latest analysis for Diageo

In the above chart we have measured Diageo'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.

What Does the ROCE Trend For Diageo Tell Us?

Things have been pretty stable at Diageo, with its capital employed and returns on that capital staying somewhat the same for the last five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Diageo doesn't end up being a multi-bagger in a few years time. This probably explains why Diageo is paying out 52% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

The Key Takeaway

In summary, Diageo isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 113% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.

On a final note, we've found 1 warning sign for Diageo that we think you should be aware of.

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

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.