There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Although, when we looked at Brown-Forman (NYSE:BF.B), it didn't seem to tick all of these boxes.
Understanding Return On Capital Employed (ROCE)
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Brown-Forman:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$1.1b ÷ (US$6.6b - US$943m) (Based on the trailing twelve months to July 2021).
So, Brown-Forman has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 13% generated by the Beverage industry.
In the above chart we have measured Brown-Forman'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 Brown-Forman.
The Trend Of ROCE
When we looked at the ROCE trend at Brown-Forman, we didn't gain much confidence. Around five years ago the returns on capital were 27%, but since then they've fallen to 19%. However it looks like Brown-Forman might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Our Take On Brown-Forman's ROCE
To conclude, we've found that Brown-Forman is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 96% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 1 warning sign with Brown-Forman and understanding it should be part of your investment process.
While Brown-Forman 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.
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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