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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? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after briefly looking over the numbers, we don't think Marshalls (LON:MSLH) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Understanding 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 Marshalls, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = UK£39m ÷ (UK£611m - UK£140m) (Based on the trailing twelve months to June 2020).
Thus, Marshalls has an ROCE of 8.3%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.3%.
In the above chart we have measured Marshalls' 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 Marshalls here for free.
What Does the ROCE Trend For Marshalls Tell Us?
When we looked at the ROCE trend at Marshalls, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.3% from 13% five years ago. 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.
The Bottom Line On Marshalls' ROCE
We're a bit apprehensive about Marshalls because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Yet despite these poor fundamentals, the stock has gained a huge 174% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
Like most companies, Marshalls does come with some risks, and we've found 5 warning signs that you should be aware of.
While Marshalls may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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