Ulta Beauty (NASDAQ:ULTA) May Have Issues Allocating Its Capital
Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Having said that, while the ROCE is currently high for Ulta Beauty (NASDAQ:ULTA), we aren't jumping out of our chairs because returns are decreasing.
Return On Capital Employed (ROCE): What is it?
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 Ulta Beauty, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$793m ÷ (US$5.1b - US$1.5b) (Based on the trailing twelve months to May 2021).
So, Ulta Beauty has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 15%.
See our latest analysis for Ulta Beauty
In the above chart we have measured Ulta Beauty's 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 Ulta Beauty here for free.
What Can We Tell From Ulta Beauty's ROCE Trend?
On the surface, the trend of ROCE at Ulta Beauty doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 32%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
What We Can Learn From Ulta Beauty's ROCE
Bringing it all together, while we're somewhat encouraged by Ulta Beauty's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 39% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you'd like to know about the risks facing Ulta Beauty, we've discovered 1 warning sign that you should be aware of.
Ulta Beauty is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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.
