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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So while Home Depot (NYSE:HD) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What Is It?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Home Depot is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = US$21b ÷ (US$97b - US$28b) (Based on the trailing twelve months to July 2024).
Therefore, Home Depot has an ROCE of 31%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.
Above you can see how the current ROCE for Home Depot compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Home Depot .
What Can We Tell From Home Depot's ROCE Trend?
When we looked at the ROCE trend at Home Depot, we didn't gain much confidence. Historically returns on capital were even higher at 48%, but they have dropped over the last five years. However it looks like Home Depot might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From Home Depot's ROCE
Bringing it all together, while we're somewhat encouraged by Home Depot's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 92% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing to note, we've identified 2 warning signs with Home Depot and understanding them should be part of your investment process.
Home Depot is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
