If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Speaking of which, we noticed some great changes in JB Hi-Fi's (ASX:JBH) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. Analysts use this formula to calculate it for JB Hi-Fi:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.35 = AU$705m ÷ (AU$3.8b - AU$1.8b) (Based on the trailing twelve months to December 2021).
So, JB Hi-Fi has an ROCE of 35%. That's a fantastic return and not only that, it outpaces the average of 19% earned by companies in a similar industry.
In the above chart we have measured JB Hi-Fi'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 JB Hi-Fi.
So How Is JB Hi-Fi's ROCE Trending?
JB Hi-Fi is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 35%. Basically the business is earning more per dollar of capital invested and in addition to that, 41% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
On a separate but related note, it's important to know that JB Hi-Fi has a current liabilities to total assets ratio of 48%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
What We Can Learn From JB Hi-Fi's ROCE
All in all, it's terrific to see that JB Hi-Fi is reaping the rewards from prior investments and is growing its capital base. And a remarkable 178% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
JB Hi-Fi does have some risks, we noticed 2 warning signs (and 1 which is a bit unpleasant) we think you should know about.
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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Find out whether JB Hi-Fi is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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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.