Home Depot (NYSE:HD) Knows How To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Home Depot (NYSE:HD) looks attractive right now, so lets see what the trend of returns can tell us.

Return On Capital Employed (ROCE): What Is It?

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. The formula for this calculation on Home Depot is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.44 = US$23b ÷ (US$76b - US$24b) (Based on the trailing twelve months to July 2023).

So, Home Depot has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 13%.

Check out our latest analysis for Home Depot

In the above chart we have measured Home Depot'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 Home Depot.

The Trend Of ROCE

We'd be pretty happy with returns on capital like Home Depot. Over the past five years, ROCE has remained relatively flat at around 44% and the business has deployed 88% more capital into its operations. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If Home Depot can keep this up, we'd be very optimistic about its future.

What We Can Learn From Home Depot's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

On a final note, we've found 2 warning signs for Home Depot that we think you should be aware of.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.