Here's What's Concerning About Reject Shop's (ASX:TRS) Returns On Capital
If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Reject Shop (ASX:TRS) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
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 Reject Shop:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = AU$20m ÷ (AU$455m - AU$194m) (Based on the trailing twelve months to December 2020).
Therefore, Reject Shop has an ROCE of 7.7%. On its own, that's a low figure but it's around the 6.5% average generated by the Multiline Retail industry.
View our latest analysis for Reject Shop
Above you can see how the current ROCE for Reject Shop compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Reject Shop.
The Trend Of ROCE
Unfortunately, the trend isn't great with ROCE falling from 17% five years ago, while capital employed has grown 63%. That being said, Reject Shop raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Reject Shop might not have received a full period of earnings contribution from it.
On a separate but related note, it's important to know that Reject Shop has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
Our Take On Reject Shop's ROCE
In summary, Reject Shop is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And in the last five years, the stock has given away 47% so the market doesn't look too hopeful on these trends strengthening any time soon. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
One more thing to note, we've identified 1 warning sign with Reject Shop and understanding it should be part of your investment process.
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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