Merchant House International (ASX:MHI) Could Become A Multi-Bagger

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of Merchant House International (ASX:MHI) looks great, so lets see what the trend can tell us.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Merchant House International is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.44 = AU$12m ÷ (AU$45m - AU$19m) (Based on the trailing twelve months to March 2021).

So, Merchant House International has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Luxury industry average of 8.7%.

See our latest analysis for Merchant House International

Historical performance is a great place to start when researching a stock so above you can see the gauge for Merchant House International's ROCE against it's prior returns. If you're interested in investigating Merchant House International's past further, check out this free graph of past earnings, revenue and cash flow.

What Can We Tell From Merchant House International's ROCE Trend?

You'd find it hard not to be impressed with the ROCE trend at Merchant House International. We found that the returns on capital employed over the last five years have risen by 1,437%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Interestingly, the business may be becoming more efficient because it's applying 44% less capital than it was five years ago. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 42% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. And with current liabilities at those levels, that's pretty high.

The Bottom Line On Merchant House International's ROCE

In the end, Merchant House International has proven it's capital allocation skills are good with those higher returns from less amount of capital. Astute investors may have an opportunity here because the stock has declined 63% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

If you'd like to know about the risks facing Merchant House International, we've discovered 3 warning signs that you should be aware of.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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