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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, we've noticed some promising trends at Kirkland's (NASDAQ:KIRK) so let's look a bit deeper.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Kirkland's, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$44m ÷ (US$365m - US$129m) (Based on the trailing twelve months to May 2021).
Therefore, Kirkland's has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 15% it's much better.
In the above chart we have measured Kirkland's' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
We like the trends that we're seeing from Kirkland's. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 19%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 31%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 35% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Bottom Line
In summary, it's great to see that Kirkland's can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a solid 70% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. In light of that, we think it's worth looking further into this stock because if Kirkland's can keep these trends up, it could have a bright future ahead.
One more thing to note, we've identified 2 warning signs with Kirkland's and understanding these should be part of your investment process.
While Kirkland's isn't earning the highest return, check out this free list of companies that are 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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