Diageo (LON:DGE) Has Some Way To Go To Become A Multi-Bagger
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. With that in mind, the ROCE of Diageo (LON:DGE) looks decent, right now, so lets see what the trend of returns can tell us.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Diageo:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = UK£3.2b ÷ (UK£33b - UK£6.7b) (Based on the trailing twelve months to December 2020).
Thus, Diageo has an ROCE of 12%. By itself that's a normal return on capital and it's in line with the industry's average returns of 12%.
See our latest analysis for Diageo
In the above chart we have measured Diageo'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 Diageo.
How Are Returns Trending?
While the returns on capital are good, they haven't moved much. The company has employed 24% more capital in the last five years, and the returns on that capital have remained stable at 12%. 12% is a pretty standard return, and it provides some comfort knowing that Diageo has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Bottom Line On Diageo's ROCE
The main thing to remember is that Diageo has proven its ability to continually reinvest at respectable rates of return. On top of that, the stock has rewarded shareholders with a remarkable 106% return to those who've held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Diageo (of which 1 doesn't sit too well with us!) that you should know about.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
This article by Simply Wall St is general in nature. 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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