Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So, when we ran our eye over Diageo's (LON:DGE) trend of ROCE, we liked what we saw.
Return On Capital Employed (ROCE): What Is It?
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)
0.18 = UK£5.3b ÷ (UK£39b - UK£9.5b) (Based on the trailing twelve months to December 2022).
So, Diageo has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Beverage industry average of 14% it's much better.
Check out 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 The Trend Of ROCE Can Tell Us
The trend of ROCE doesn't stand out much, but returns on a whole are decent. Over the past five years, ROCE has remained relatively flat at around 18% and the business has deployed 28% more capital into its operations. 18% is a pretty standard return, and it provides some comfort knowing that Diageo has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
In Conclusion...
To sum it up, Diageo has simply been reinvesting capital steadily, at those decent rates of return. And the stock has followed suit returning a meaningful 56% to shareholders over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we've spotted 1 warning sign facing Diageo that you might find interesting.
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.
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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.
About LSE:DGE
Diageo
Engages in the production, marketing, and sale of alcoholic beverages.
Established dividend payer and good value.
