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The Returns At Michael Hill International (ASX:MHJ) Provide Us With Signs Of What's To Come

Simply Wall St
·3 min read

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after briefly looking over the numbers, we don't think Michael Hill International (ASX:MHJ) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 Michael Hill International, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.059 = AU$20m ÷ (AU$502m - AU$159m) (Based on the trailing twelve months to June 2020).

So, Michael Hill International has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 16%.

See our latest analysis for Michael Hill International

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Above you can see how the current ROCE for Michael Hill International 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 Michael Hill International.

The Trend Of ROCE

When we looked at the ROCE trend at Michael Hill International, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

In summary, we're somewhat concerned by Michael Hill International's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 58% depreciation in their investment, so it appears the market might not like these trends either. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

On a separate note, we've found 2 warning signs for Michael Hill International you'll probably want to know about.

While Michael Hill International 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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