If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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 on that note, Meritage Homes (NYSE:MTH) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
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 Meritage Homes:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$995m ÷ (US$6.2b - US$655m) (Based on the trailing twelve months to September 2023).
So, Meritage Homes has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 14% generated by the Consumer Durables industry.
Check out our latest analysis for Meritage Homes
In the above chart we have measured Meritage Homes' 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 Meritage Homes here for free.
How Are Returns Trending?
Meritage Homes is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 18%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 79%. So we're very much inspired by what we're seeing at Meritage Homes thanks to its ability to profitably reinvest capital.
What We Can Learn From Meritage Homes' ROCE
To sum it up, Meritage Homes has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you want to continue researching Meritage Homes, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Meritage 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.