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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Skechers U.S.A (NYSE:SKX) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Skechers U.S.A is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.056 = US$266m ÷ (US$6.0b - US$1.3b) (Based on the trailing twelve months to March 2021).
Therefore, Skechers U.S.A has an ROCE of 5.6%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 10%.
In the above chart we have measured Skechers U.S.A'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 Skechers U.S.A.
What The Trend Of ROCE Can Tell Us
In terms of Skechers U.S.A's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 5.6% from 25% five years ago. 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 may take some time before the company starts to see any change in earnings from these investments.
The Bottom Line
To conclude, we've found that Skechers U.S.A is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 66% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
One more thing to note, we've identified 2 warning signs with Skechers U.S.A and understanding these should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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