Nick Scali (ASX:NCK) Might Be Having Difficulty Using Its Capital Effectively

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, while the ROCE is currently high for Nick Scali (ASX:NCK), we aren't jumping out of our chairs because returns are decreasing.

Return On Capital Employed (ROCE): What is it?

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 Nick Scali, this is the formula:

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

0.29 = AU$120m ÷ (AU$590m - AU$176m) (Based on the trailing twelve months to December 2021).

So, Nick Scali has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 19%.

Check out our latest analysis for Nick Scali

Above you can see how the current ROCE for Nick Scali compares to its prior returns on capital, but there's only so much you can tell from the past. 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

When we looked at the ROCE trend at Nick Scali, we didn't gain much confidence. Historically returns on capital were even higher at 50%, but they have dropped over the last five years. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line On Nick Scali's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Nick Scali. Furthermore the stock has climbed 66% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

Nick Scali does have some risks though, and we've spotted 2 warning signs for Nick Scali that you might be interested in.

Nick Scali is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.