There are a few key trends to look for if we want to identify the next 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. However, after investigating Michael Hill International (ASX:MHJ), we don't think it's current trends fit the mold of a multi-bagger.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from 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)
0.059 = AU$20m ÷ (AU$502m - AU$159m) (Based on the trailing twelve months to June 2020).
Therefore, Michael Hill International has an ROCE of 5.9%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 16%.
Above you can see how the current ROCE for Michael Hill International compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Michael Hill International.
The Trend Of ROCE
In terms of Michael Hill International's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 5.9%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 32%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 5.9%. 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.
The Key Takeaway
In summary, we're somewhat concerned by Michael Hill International's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last three years have experienced a 36% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
On a final note, we've found 3 warning signs for Michael Hill International 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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