- Oops!Something went wrong.Please try again later.
There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in RH's (NYSE:RH) returns on capital, so let's have a look.
Understanding 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. Analysts use this formula to calculate it for RH:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = US$617m ÷ (US$2.9b - US$922m) (Based on the trailing twelve months to January 2021).
Thus, RH has an ROCE of 31%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.
In the above chart we have measured RH's 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 RH.
What The Trend Of ROCE Can Tell Us
RH is displaying some positive trends. Over the last five years, returns on capital employed have risen substantially to 31%. The amount of capital employed has increased too, by 21%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
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 32% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
The Key Takeaway
All in all, it's terrific to see that RH is reaping the rewards from prior investments and is growing its capital base. And a remarkable 1,869% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if RH can keep these trends up, it could have a bright future ahead.
On a final note, we've found 4 warning signs for RH that we think 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.