Did you know there are some financial metrics that can provide clues of a potential multi-bagger? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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 Burberry Group (LON:BRBY), it didn't seem to tick all of these boxes.
What is Return On Capital Employed (ROCE)?
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. Analysts use this formula to calculate it for Burberry Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£415m ÷ (UK£3.5b - UK£703m) (Based on the trailing twelve months to March 2021).
So, Burberry Group has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Luxury industry average of 8.5% it's much better.
In the above chart we have measured Burberry Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Burberry Group here for free.
The Trend Of ROCE
When we looked at the ROCE trend at Burberry Group, we didn't gain much confidence. Around five years ago the returns on capital were 23%, but since then they've fallen to 15%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
What We Can Learn From Burberry Group's ROCE
We're a bit apprehensive about Burberry Group because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Since the stock has skyrocketed 127% over the last five years, it looks like investors have high expectations of the stock. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.
One more thing, we've spotted 2 warning signs facing Burberry Group that you might find interesting.
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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