If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. In light of that, when we looked at Michael Hill International (ASX:MHJ) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Michael Hill International is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.078 = AU$32m ÷ (AU$584m - AU$170m) (Based on the trailing twelve months to June 2020).
Therefore, Michael Hill International has an ROCE of 7.8%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.
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.
What Does the ROCE Trend For Michael Hill International Tell Us?
On the surface, the trend of ROCE at Michael Hill International doesn't inspire confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 7.8%. 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's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Key Takeaway
To conclude, we've found that Michael Hill International is reinvesting in the business, but returns have been falling. And in the last three years, the stock has given away 69% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
One more thing to note, we've identified 3 warning signs with Michael Hill International and understanding them should be part of your investment process.
While Michael Hill International 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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