Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. So, when we ran our eye over Diageo's (LON:DGE) trend of ROCE, we liked what we saw.
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)
0.17 = UK£4.8b ÷ (UK£37b - UK£8.4b) (Based on the trailing twelve months to June 2022).
Therefore, Diageo has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 9.3% generated by the Beverage industry.
Our analysis indicates that DGE is potentially undervalued!
Above you can see how the current ROCE for Diageo compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Diageo here for free.
What Does the ROCE Trend For Diageo Tell Us?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 17% for the last five years, and the capital employed within the business has risen 26% in that time. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Key Takeaway
In the end, Diageo has proven its ability to adequately reinvest capital at good rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Like most companies, Diageo does come with some risks, and we've found 1 warning sign that you should be aware of.
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.
New: Manage All Your Stock Portfolios in One Place
We've created the ultimate portfolio companion for stock investors, and it's free.
• Connect an unlimited number of Portfolios and see your total in one currency
• Be alerted to new Warning Signs or Risks via email or mobile
• Track the Fair Value of your stocks
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.
About LSE:DGE
Diageo
Engages in the production, marketing, and sale of alcoholic beverages.
Established dividend payer and good value.
