If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. So, when we ran our eye over Michael Hill International's (ASX:MHJ) trend of ROCE, we liked what we saw.
What is 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. Analysts use this formula to calculate it for Michael Hill International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = AU$60m ÷ (AU$508m - AU$152m) (Based on the trailing twelve months to June 2021).
Therefore, Michael Hill International has an ROCE of 17%. That's a relatively normal return on capital, and it's around the 20% generated by the Specialty Retail industry.
In the above chart we have measured Michael Hill International'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 The Trend Of ROCE Can Tell Us
While the returns on capital are good, they haven't moved much. Over the past five years, ROCE has remained relatively flat at around 17% and the business has deployed 26% more capital into its operations. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
The Bottom Line On Michael Hill International's ROCE
In the end, Michael Hill International has proven its ability to adequately reinvest capital at good rates of return. Therefore it's no surprise that shareholders have earned a respectable 40% return if they held over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
If you want to know some of the risks facing Michael Hill International we've found 5 warning signs (1 doesn't sit too well with us!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.