The Returns At Reject Shop (ASX:TRS) Provide Us With Signs Of What's To Come

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. 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. Although, when we looked at Reject Shop (ASX:TRS), it didn't seem to tick all of these boxes.

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. 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)

0.039 = AU$10m ÷ (AU$422m - AU$165m) (Based on the trailing twelve months to June 2020).

Therefore, Reject Shop has an ROCE of 3.9%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 6.6%.

View our latest analysis for Reject Shop

In the above chart we have measured Reject Shop's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Reject Shop here for free.

What Can We Tell From Reject Shop's ROCE Trend?

We weren't thrilled with the trend because Reject Shop's ROCE has reduced by 71% over the last five years, while the business employed 61% more capital. Usually this isn't ideal, but given Reject Shop conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Reject Shop might not have received a full period of earnings contribution from it.

The Bottom Line

In summary, Reject Shop is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has declined 26% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

Like most companies, Reject Shop does come with some risks, and we've found 2 warning signs 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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This article by Simply Wall St is general in nature. 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.
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