If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Reject Shop (ASX:TRS), it didn't seem to tick all of these boxes.
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 Reject Shop is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.039 = AU$10m ÷ (AU$422m - AU$165m) (Based on the trailing twelve months to June 2020).
So, Reject Shop has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 6.3%.
In the above chart we have measured Reject Shop's 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 Reject Shop here for free.
What The Trend Of ROCE Can Tell Us
The trend of ROCE doesn't look fantastic because it's fallen from 14% five years ago, while the business's capital employed increased by 61%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Reject Shop's earnings and if they change as a result from the capital raise.
The Key Takeaway
To conclude, we've found that Reject Shop is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 21% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.
One more thing, we've spotted 2 warning signs facing Reject Shop that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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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