Here's What To Make Of Diageo's (LON:DGE) Decelerating Rates Of Return

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Diageo (LON:DGE) looks decent, right now, so lets see what the trend of returns can tell us.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Diageo:

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 12% it's much better.

View our latest analysis for Diageo

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.

SWOT Analysis for Diageo

What Can We Tell From Diageo's ROCE Trend?

While the returns on capital are good, they haven't moved much. The company has employed 28% more capital in the last five years, and the returns on that capital have remained stable at 18%. 18% is a pretty standard return, and it provides some comfort knowing that Diageo has consistently earned this amount. 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

The main thing to remember is that Diageo has proven its ability to continually reinvest at respectable 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.

If you'd like to know more about Diageo, we've spotted 2 warning signs, and 1 of them is potentially serious.

While Diageo may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.