Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Starbucks (NASDAQ:SBUX) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for Starbucks, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.089 = US$1.9b ÷ (US$29b - US$8.0b) (Based on the trailing twelve months to June 2020).
Thus, Starbucks has an ROCE of 8.9%. In absolute terms, that's a low return, but it's much better than the Hospitality industry average of 5.4%.
In the above chart we have measured Starbucks' 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 Starbucks here for free.
How Are Returns Trending?
When we looked at the ROCE trend at Starbucks, we didn't gain much confidence. Around five years ago the returns on capital were 37%, but since then they've fallen to 8.9%. However it looks like Starbucks 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.
The Key Takeaway
To conclude, we've found that Starbucks is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 54% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
One more thing: We've identified 5 warning signs with Starbucks (at least 2 which can't be ignored) , and understanding these would certainly be useful.
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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