If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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. Having said that, from a first glance at LGI Homes (NASDAQ:LGIH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
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. The formula for this calculation on LGI Homes is:
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%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 15%.
In the above chart we have measured LGI Homes' 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 LGI Homes.
What Can We Tell From LGI Homes' ROCE Trend?
In terms of LGI Homes' historical ROCE movements, the trend isn't fantastic. 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. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Key Takeaway
In summary, we're somewhat concerned by LGI Homes' diminishing returns on increasing amounts of capital. Since the stock has skyrocketed 105% over the last five years, it looks like investors have high expectations of the stock. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you'd like to know more about LGI Homes, we've spotted 2 warning signs, and 1 of them is a bit unpleasant.
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.