There are a few key trends to look for if we want to identify the next multi-bagger. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. Speaking of which, we noticed some great changes in Hovnanian Enterprises' (NYSE:HOV) returns on capital, so let's have a look.

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 Hovnanian Enterprises:

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

0.15 = US$275m ÷ (US$2.3b - US$469m) (Based on the trailing twelve months to January 2024).

Therefore, Hovnanian Enterprises has an ROCE of 15%. That's a pretty standard return and it's in line with the industry average of 15%.

While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Hovnanian Enterprises' past further, check out this free graph covering Hovnanian Enterprises' past earnings, revenue and cash flow.

The Trend Of ROCE

Investors would be pleased with what's happening at Hovnanian Enterprises. The data shows that returns on capital have increased substantially over the last five years to 15%. Basically the business is earning more per dollar of capital invested and in addition to that, 28% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 20% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

In summary, it's great to see that Hovnanian Enterprises can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 868% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Hovnanian Enterprises can keep these trends up, it could have a bright future ahead.

Like most companies, Hovnanian Enterprises does come with some risks, and we've found 2 warning signs that you should be aware of.

While Hovnanian Enterprises 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.