To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 LGI Homes (NASDAQ:LGIH), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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. Analysts use this formula to calculate it for LGI Homes:

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

0.069 = US$221m ÷ (US$3.3b - US$121m) (Based on the trailing twelve months to September 2023).

So, LGI Homes has an ROCE of 6.9%. In absolute terms, that's a low return and it also under-performs the Consumer Durables industry average of 15%.

Check out our latest analysis for LGI Homes

Above you can see how the current ROCE for LGI Homes compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at LGI Homes, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

What We Can Learn From LGI Homes' ROCE

In summary, we're somewhat concerned by LGI Homes' diminishing returns on increasing amounts of capital. The market must be rosy on the stock's future because even though the underlying trends aren't too encouraging, the stock has soared 189%. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 2 warning signs for LGI Homes (of which 1 shouldn't be ignored!) that you should know about.

While LGI Homes isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.