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. With that in mind, we've noticed some promising trends at Hovnanian Enterprises (NYSE:HOV) so let's look a bit deeper.

What Is 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)

0.14 = US$277m ÷ (US$2.5b - US$561m) (Based on the trailing twelve months to July 2024).

Thus, Hovnanian Enterprises has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Hovnanian Enterprises' ROCE against it's prior returns. If you want to delve into the historical earnings , check out these free graphs detailing revenue and cash flow performance of Hovnanian Enterprises.

How Are Returns Trending?

The trends we've noticed at Hovnanian Enterprises are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 14%. Basically the business is earning more per dollar of capital invested and in addition to that, 25% 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. Effectively this means that suppliers or short-term creditors are now funding 22% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line

All in all, it's terrific to see that Hovnanian Enterprises is reaping the rewards from prior investments and is growing its capital base. And a remarkable 715% 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.

If you want to know some of the risks facing Hovnanian Enterprises we've found 2 warning signs (1 shouldn't be ignored!) that you should be aware of before investing here.

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.