What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Having said that, from a first glance at Callaway Golf (NYSE:ELY) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Callaway Golf is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.03 = US$46m ÷ (US$1.9b - US$344m) (Based on the trailing twelve months to June 2020).
Thus, Callaway Golf has an ROCE of 3.0%. In absolute terms, that's a low return and it also under-performs the Leisure industry average of 17%.
In the above chart we have measured Callaway Golf'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.
The Trend Of ROCE
In terms of Callaway Golf's historical ROCE trend, it doesn't exactly demand attention. The company has employed 208% more capital in the last five years, and the returns on that capital have remained stable at 3.0%. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Bottom Line
Long story short, while Callaway Golf has been reinvesting its capital, the returns that it's generating haven't increased. Investors must think there's better things to come because the stock has knocked it out of the park delivering a 123% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Callaway Golf does have some risks though, and we've spotted 1 warning sign for Callaway Golf that you might be interested in.
While Callaway Golf 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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