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What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. With that in mind, we've noticed some promising trends at M.D.C. Holdings (NYSE:MDC) so let's look a bit deeper.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on M.D.C. Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$554m ÷ (US$4.4b - US$748m) (Based on the trailing twelve months to March 2021).
Therefore, M.D.C. Holdings has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Durables industry average of 14%.
Above you can see how the current ROCE for M.D.C. Holdings compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering M.D.C. Holdings here for free.
The Trend Of ROCE
We like the trends that we're seeing from M.D.C. Holdings. 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, 72% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
What We Can Learn From M.D.C. Holdings' ROCE
In summary, it's great to see that M.D.C. Holdings 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. Since the stock has returned a staggering 198% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you want to know some of the risks facing M.D.C. Holdings we've found 2 warning signs (1 is significant!) that you should be aware of before investing here.
While M.D.C. Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. 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.
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