There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Speaking of which, we noticed some great changes in Hovnanian Enterprises' (NYSE:HOV) returns on capital, so let's have a look.
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 Hovnanian Enterprises:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$310m ÷ (US$2.4b - US$382m) (Based on the trailing twelve months to April 2022).
Therefore, Hovnanian Enterprises has an ROCE of 16%. That's a pretty standard return and it's in line with the industry average of 16%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you want to delve into the historical earnings, revenue and cash flow of Hovnanian Enterprises, check out these free graphs here.
What Can We Tell From Hovnanian Enterprises' ROCE Trend?
Hovnanian Enterprises is showing promise given that its ROCE is trending up and to the right. The figures show that over the last five years, ROCE has grown 272% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Bottom Line On Hovnanian Enterprises' ROCE
To sum it up, Hovnanian Enterprises is collecting higher returns from the same amount of capital, and that's impressive. Given the stock has declined 32% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
If you want to know some of the risks facing Hovnanian Enterprises we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.
While Hovnanian Enterprises 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.