Did you know there are some financial metrics that can provide clues of a potential 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. Although, when we looked at Hovnanian Enterprises (NYSE:HOV), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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 Hovnanian Enterprises:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.043 = US$70m ÷ (US$1.9b - US$275m) (Based on the trailing twelve months to April 2020).
Thus, Hovnanian Enterprises has an ROCE of 4.3%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 11%.
Historical performance is a great place to start when researching a stock so above you can see the gauge for Hovnanian Enterprises' ROCE against it's prior returns. If you'd like to look at how Hovnanian Enterprises has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.
What Can We Tell From Hovnanian Enterprises' ROCE Trend?
There hasn't been much to report for Hovnanian Enterprises' returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So don't be surprised if Hovnanian Enterprises doesn't end up being a multi-bagger in a few years time.
The Bottom Line On Hovnanian Enterprises' ROCE
In summary, Hovnanian Enterprises isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And investors appear hesitant that the trends will pick up because the stock has fallen 55% in the last five years. Therefore based on the analysis done in this article, we don't think Hovnanian Enterprises has the makings of a multi-bagger.
Hovnanian Enterprises does have some risks, we noticed 3 warning signs (and 1 which shouldn't be ignored) we think you should know about.
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.
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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