Baby Bunting Group (ASX:BBN) Could Be Struggling To Allocate Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. However, after investigating Baby Bunting Group (ASX:BBN), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Baby Bunting Group, this is the formula:

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

0.14 = AU$35m ÷ (AU$351m - AU$95m) (Based on the trailing twelve months to June 2022).

Thus, Baby Bunting Group has an ROCE of 14%. In absolute terms, that's a pretty standard return but compared to the Specialty Retail industry average it falls behind.

See our latest analysis for Baby Bunting Group

In the above chart we have measured Baby Bunting Group's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Baby Bunting Group Tell Us?

When we looked at the ROCE trend at Baby Bunting Group, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 14% from 18% 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.

Our Take On Baby Bunting Group's ROCE

Bringing it all together, while we're somewhat encouraged by Baby Bunting Group's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 89% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 1 warning sign for Baby Bunting Group that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.