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. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Domino's Pizza Enterprises (ASX:DMP), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Domino's Pizza Enterprises is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = AU$209m ÷ (AU$2.5b - AU$536m) (Based on the trailing twelve months to June 2020).
Thus, Domino's Pizza Enterprises has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Hospitality industry average of 7.9% it's much better.
In the above chart we have measured Domino's Pizza Enterprises' 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 Domino's Pizza Enterprises here for free.
What Does the ROCE Trend For Domino's Pizza Enterprises Tell Us?
When we looked at the ROCE trend at Domino's Pizza Enterprises, we didn't gain much confidence. To be more specific, ROCE has fallen from 19% over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
What We Can Learn From Domino's Pizza Enterprises' ROCE
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Domino's Pizza Enterprises. Furthermore the stock has climbed 95% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
If you'd like to know about the risks facing Domino's Pizza Enterprises, we've discovered 1 warning sign that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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