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

By
Simply Wall St
Published
March 25, 2022
LSE:DGE
Source: Shutterstock

If you're looking for a multi-bagger, there's a few things to 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Diageo (LON:DGE) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Diageo, this is the formula:

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

0.17 = UK£4.2b ÷ (UK£33b - UK£7.6b) (Based on the trailing twelve months to December 2021).

Therefore, Diageo has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Beverage industry average of 13% it's much better.

View our latest analysis for Diageo

roce
LSE:DGE Return on Capital Employed March 25th 2022

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 The Trend Of ROCE Can 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. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Diageo to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that Diageo has been paying out a decent 51% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

The Bottom Line

We can conclude that in regards to Diageo's returns on capital employed and the trends, there isn't much change to report on. Although the market must be expecting these trends to improve because the stock has gained 82% over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a separate note, we've found 1 warning sign for Diageo you'll probably want to know about.

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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