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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So, when we ran our eye over Diageo's (LON:DGE) trend of ROCE, we liked what we saw.
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. The formula for this calculation on Diageo is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = UK£3.5b ÷ (UK£33b - UK£6.5b) (Based on the trailing twelve months to June 2020).
So, Diageo has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Beverage industry average of 12%.
Above you can see how the current ROCE for Diageo compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Diageo here for free.
What Does the ROCE Trend For Diageo Tell Us?
The trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has consistently earned 13% for the last five years, and the capital employed within the business has risen 31% in that time. Since 13% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. 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.
In the end, Diageo has proven its ability to adequately reinvest capital at good rates of return. Therefore it's no surprise that shareholders have earned a respectable 80% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
One more thing: We've identified 4 warning signs with Diageo (at least 1 which doesn't sit too well with us) , and understanding these would certainly be useful.
While Diageo isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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