There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Redrow (LON:RDW) looks decent, right now, so lets see what the trend of returns can tell us.
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 Redrow:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = UK£414m ÷ (UK£3.2b - UK£1.0b) (Based on the trailing twelve months to July 2022).
Thus, Redrow has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 14% generated by the Consumer Durables industry.
Above you can see how the current ROCE for Redrow 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 Redrow here for free.
What Does the ROCE Trend For Redrow Tell Us?
While the returns on capital are good, they haven't moved much. The company has consistently earned 19% for the last five years, and the capital employed within the business has risen 41% in that time. Since 19% 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.
The Bottom Line
The main thing to remember is that Redrow has proven its ability to continually reinvest at respectable rates of return. Yet over the last five years the stock has declined 14%, so the decline might provide an opening. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
One more thing to note, we've identified 2 warning signs with Redrow and understanding these should be part of your investment process.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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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