Domino's Pizza Enterprises (ASX:DMP) May Have Issues Allocating Its Capital

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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Although, when we looked at Domino's Pizza Enterprises (ASX:DMP), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for Domino's Pizza Enterprises:

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

0.094 = AU$203m ÷ (AU$3.0b - AU$779m) (Based on the trailing twelve months to January 2023).

Thus, Domino's Pizza Enterprises has an ROCE of 9.4%. In absolute terms, that's a low return but it's around the Hospitality industry average of 8.1%.

View our latest analysis for Domino's Pizza Enterprises

Above you can see how the current ROCE for Domino's Pizza Enterprises compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From Domino's Pizza Enterprises' ROCE Trend?

In terms of Domino's Pizza Enterprises' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 17%, but since then they've fallen to 9.4%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Domino's Pizza Enterprises' current liabilities have increased over the last five years to 26% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 9.4%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

In Conclusion...

In summary, Domino's Pizza Enterprises is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Unsurprisingly then, the total return to shareholders over the last five years has been flat. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

One more thing, we've spotted 3 warning signs facing Domino's Pizza Enterprises that you might find interesting.

While Domino's Pizza Enterprises isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.