What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Having said that, while the ROCE is currently high for Herbalife (NYSE:HLF), we aren't jumping out of our chairs because returns are decreasing.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Herbalife:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.27 = US$424m ÷ (US$2.7b - US$1.2b) (Based on the trailing twelve months to September 2023).
Therefore, Herbalife has an ROCE of 27%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.
In the above chart we have measured Herbalife's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Herbalife.
What Can We Tell From Herbalife's ROCE Trend?
When we looked at the ROCE trend at Herbalife, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 58%. However it looks like Herbalife might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, Herbalife has done well to pay down its current liabilities to 43% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.
Our Take On Herbalife's ROCE
To conclude, we've found that Herbalife is reinvesting in the business, but returns have been falling. And investors may be expecting the fundamentals to get a lot worse because the stock has crashed 80% over the last five years. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Herbalife does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are potentially serious...
Herbalife is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.