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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at Booktopia Group (ASX:BKG), it didn't seem to tick all of these boxes.
Understanding 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. Analysts use this formula to calculate it for Booktopia Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.054 = AU$3.6m ÷ (AU$109m - AU$41m) (Based on the trailing twelve months to December 2021).
Therefore, Booktopia Group has an ROCE of 5.4%. In absolute terms, that's a low return and it also under-performs the Online Retail industry average of 10%.
Above you can see how the current ROCE for Booktopia Group 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 Booktopia Group here for free.
What Can We Tell From Booktopia Group's ROCE Trend?
In terms of Booktopia Group's historical ROCE movements, the trend isn't fantastic. Around two years ago the returns on capital were 22%, but since then they've fallen to 5.4%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
On a related note, Booktopia Group has decreased its current liabilities to 38% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
In summary, despite lower returns in the short term, we're encouraged to see that Booktopia Group is reinvesting for growth and has higher sales as a result. Despite these promising trends, the stock has collapsed 91% over the last year, so there could be other factors hurting the company's prospects. Therefore, we'd suggest researching the stock further to uncover more about the business.
On a final note, we've found 2 warning signs for Booktopia Group that we think you should be aware of.
While Booktopia Group 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.
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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.