I am writing today to help inform people who are new to the stock market and looking to gauge the potential return on investment in The New Home Company Inc (NYSE:NWHM).
Purchasing New Home gives you an ownership stake in the company. Your equity share is granted in return for the capital provided to the business to operate, and in order for an investment to be successful the business has to create earnings from the funds that make up this capital. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Thus, to understand how your money can grow by investing in New Home, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
New Home’s Return On Capital Employed
As an investor you have many alternative companies to choose from, which means there is an opportunity cost in any investment you make in the form of a foregone investment in another company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. A good metric to use is return on capital employed (ROCE), which helps us gauge how much income can be created from the funds needed to operate the business. This metric will tell us if New Home is good at growing investor capital. Take a look at the formula box beneath:
ROCE Calculation for NWHM
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$25m ÷ (US$709m – US$69m) = 3.9%
The calculation above shows that NWHM’s earnings were 3.9% of capital employed. This makes New Home disappointing when compared to a robust 15% ROCE yardstick. So if this rate continues in to the future, investor capital may be able to compound over time, but not to standard that investors should be aiming for.
Why is this the case?
The underperforming ROCE is not ideal for New Home investors if the company is unable to turn things around. But if the underlying variables (earnings and capital employed) improve, NWHM’s ROCE may increase, in which case your portfolio could benefit from holding the company. Because of this, it is important to look beyond the final value of NWHM’s ROCE and understand what is happening to the individual components. Looking at the past 3 year period shows us that NWHM weakened investor return on capital employed from 6.9%. With this, the current earnings of US$25m improved from US$23m however capital employed has improved by a proportionally greater amount as a result of an increase in total assets , which means that although earnings have increased, NWHM requires more capital to produce each $1 of earnings.
NWHM’s investors have experienced a downward trend in ROCE and it is currently at a level that makes us question whether the company is capable of providing a suitable return on investment. Before making any decisions, ROCE does not tell the whole picture so you need to pay attention to other fundamentals like future prospects and management ability. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for NWHM’s future growth? Take a look at our free research report of analyst consensus for NWHM’s outlook.
- Management:Have insiders been ramping up their shares to take advantage of the market’s sentiment for New Home’s future outlook? Check out our management and board analysis with insights on CEO compensation and governance factors.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.