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Here's What's Concerning About New Home's (NYSE:NWHM) Returns On Capital

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. In light of that, from a first glance at New Home (NYSE:NWHM), we've spotted some signs that it could be struggling, so let's investigate.

Understanding 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. To calculate this metric for New Home, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.017 = US$8.3m ÷ (US$540m - US$60m) (Based on the trailing twelve months to March 2021).

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Thus, New Home has an ROCE of 1.7%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 14%.

Check out our latest analysis for New Home

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Historical performance is a great place to start when researching a stock so above you can see the gauge for New Home's ROCE against it's prior returns. If you want to delve into the historical earnings, revenue and cash flow of New Home, check out these free graphs here.

So How Is New Home's ROCE Trending?

We are a bit worried about the trend of returns on capital at New Home. To be more specific, the ROCE was 3.5% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on New Home becoming one if things continue as they have.

What We Can Learn From New Home's ROCE

All in all, the lower returns from the same amount of capital employed aren't exactly signs of a compounding machine. Investors haven't taken kindly to these developments, since the stock has declined 39% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

One more thing: We've identified 3 warning signs with New Home (at least 2 which are a bit concerning) , and understanding these would certainly be useful.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.