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

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. 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.

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Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the 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)

0.16 = US$5.8b ÷ (US$47b - US$10b) (Based on the trailing twelve months to December 2024).

Thus, Diageo has an ROCE of 16%. That's a pretty standard return and it's in line with the industry average of 16%.

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 analyst report for Diageo .

What Can We Tell From Diageo's ROCE Trend?

While the returns on capital are good, they haven't moved much. Over the past five years, ROCE has remained relatively flat at around 16% and the business has deployed 20% more capital into its operations. Since 16% 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.

In Conclusion...

In the end, Diageo has proven its ability to adequately reinvest capital at good rates of return. However, despite the favorable fundamentals, the stock has fallen 20% over the last five years, so there might be an opportunity here for astute investors. For that reason, savvy investors might want to look further into this company in case it's a prime investment.

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

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.