If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Houghton Mifflin Harcourt's (NASDAQ:HMHC) returns on capital, so let's have a look.
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. To calculate this metric for Houghton Mifflin Harcourt, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.029 = US$43m ÷ (US$2.1b - US$600m) (Based on the trailing twelve months to September 2021).
So, Houghton Mifflin Harcourt has an ROCE of 2.9%. Ultimately, that's a low return and it under-performs the Consumer Services industry average of 7.4%.
In the above chart we have measured Houghton Mifflin Harcourt's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Houghton Mifflin Harcourt.
What Does the ROCE Trend For Houghton Mifflin Harcourt Tell Us?
It's great to see that Houghton Mifflin Harcourt has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 2.9% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 41% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. This could potentially mean that the company is selling some of its assets.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 29% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Bottom Line On Houghton Mifflin Harcourt's ROCE
In a nutshell, we're pleased to see that Houghton Mifflin Harcourt has been able to generate higher returns from less capital. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 52% return over the last five years. In light of that, we think it's worth looking further into this stock because if Houghton Mifflin Harcourt can keep these trends up, it could have a bright future ahead.
While Houghton Mifflin Harcourt looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether HMHC is currently trading for a fair price.
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.
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.
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