What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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, we've noticed some promising trends at Hovnanian Enterprises (NYSE:HOV) so let's look a bit deeper.
What Is 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. Analysts use this formula to calculate it for Hovnanian Enterprises:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$343m ÷ (US$2.5b - US$412m) (Based on the trailing twelve months to July 2022).
So, Hovnanian Enterprises has an ROCE of 16%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Durables industry average of 17%.
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 want to delve into the historical earnings, revenue and cash flow of Hovnanian Enterprises, check out these free graphs here.
How Are Returns Trending?
We like the trends that we're seeing from Hovnanian Enterprises. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 16%. Basically the business is earning more per dollar of capital invested and in addition to that, 40% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
The Bottom Line On Hovnanian Enterprises' ROCE
In summary, it's great to see that Hovnanian Enterprises can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Given the stock has declined 21% 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.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 4 warning signs for Hovnanian Enterprises (of which 1 is concerning!) that you should know about.
While Hovnanian Enterprises isn't earning the highest return, check out this free list of companies that are 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.
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