PetMed Express (NASDAQ:PETS) Could Be Struggling To Allocate Capital
What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while PetMed Express (NASDAQ:PETS) has a high ROCE right now, lets see what we can decipher from how returns are changing.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for PetMed Express, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = US$38m ÷ (US$187m - US$45m) (Based on the trailing twelve months to March 2021).
Therefore, PetMed Express has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Online Retail industry average of 14%.
View our latest analysis for PetMed Express
In the above chart we have measured PetMed Express' prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for PetMed Express.
What Does the ROCE Trend For PetMed Express Tell Us?
On the surface, the trend of ROCE at PetMed Express doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 39% where it was five years ago. However it looks like PetMed Express might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, PetMed Express' current liabilities have increased over the last five years to 24% of total assets, effectively distorting the ROCE to some degree. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.
In Conclusion...
In summary, PetMed Express is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Although the market must be expecting these trends to improve because the stock has gained 94% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
Like most companies, PetMed Express does come with some risks, and we've found 2 warning signs that you should be aware of.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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