Returns On Capital At Reject Shop (ASX:TRS) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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. However, after investigating Reject Shop (ASX:TRS), we don't think it's current trends fit the mold of a multi-bagger.

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

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. To calculate this metric for Reject Shop, this is the formula:

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

0.077 = AU$20m ÷ (AU$455m - AU$194m) (Based on the trailing twelve months to December 2020).

Thus, Reject Shop has an ROCE of 7.7%. On its own, that's a low figure but it's around the 6.6% average generated by the Multiline Retail industry.

See our latest analysis for Reject Shop

Above you can see how the current ROCE for Reject Shop 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.

So How Is Reject Shop's ROCE Trending?

The trend of ROCE doesn't look fantastic because it's fallen from 17% five years ago, while the business's capital employed increased by 63%. That being said, Reject Shop raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. Reject Shop probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

Another thing to note, Reject Shop has a high ratio of current liabilities to total assets of 43%. 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.

The Bottom Line On Reject Shop's ROCE

Bringing it all together, while we're somewhat encouraged by Reject Shop's reinvestment in its own business, we're aware that returns are shrinking. And investors appear hesitant that the trends will pick up because the stock has fallen 42% in the last five years. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Reject Shop, we've discovered 1 warning sign that you should be aware of.

While Reject Shop may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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