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There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while HP (NYSE:HPQ) has a high ROCE right now, lets see what we can decipher from how returns are changing.
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. Analysts use this formula to calculate it for HP:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.37 = US$4.2b ÷ (US$40b - US$29b) (Based on the trailing twelve months to October 2024).
So, HP has an ROCE of 37%. That's a fantastic return and not only that, it outpaces the average of 8.7% earned by companies in a similar industry.
View our latest analysis for HP
In the above chart we have measured HP's 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 HP for free.
So How Is HP's ROCE Trending?
In terms of HP's historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 52% where it was five years ago. However it looks like HP 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 separate but related note, it's important to know that HP has a current liabilities to total assets ratio of 72%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On HP's ROCE
To conclude, we've found that HP is reinvesting in the business, but returns have been falling. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 103% gain to shareholders who have held over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.