Returns On Capital At HP (NYSE:HPQ) Paint A Concerning Picture

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while HP (NYSE:HPQ) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. The formula for this calculation on HP is:

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

0.34 = US$4.2b ÷ (US$37b - US$24b) (Based on the trailing twelve months to October 2023).

Thus, HP has an ROCE of 34%. That's a fantastic return and not only that, it outpaces the average of 7.5% earned by companies in a similar industry.

View our latest analysis for HP

In the above chart we have measured HP'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 HP.

How Are Returns Trending?

In terms of HP's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 46%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

On a side note, HP's current liabilities are still rather high at 66% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From HP's ROCE

From the above analysis, we find it rather worrisome that returns on capital and sales for HP have fallen, meanwhile the business is employing more capital than it was five years ago. However the stock has delivered a 42% return to shareholders over the last five years, so investors might be expecting the trends to turn around. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

HP does have some risks, we noticed 5 warning signs (and 2 which are a bit concerning) we think you should know about.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.