Aritzia (TSE:ATZ) Knows How To Allocate Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. And in light of that, the trends we're seeing at Aritzia's (TSE:ATZ) look very promising so lets take a look.

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 Aritzia:

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

0.23 = CA$234m ÷ (CA$1.4b - CA$420m) (Based on the trailing twelve months to November 2021).

So, Aritzia has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 18% earned by companies in a similar industry.

See our latest analysis for Aritzia

In the above chart we have measured Aritzia's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Aritzia.

What Can We Tell From Aritzia's ROCE Trend?

We're delighted to see that Aritzia is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 23% which is a sight for sore eyes. In addition to that, Aritzia is employing 164% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 29% of the business, which is more than it was five years ago. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

In Conclusion...

In summary, it's great to see that Aritzia has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a staggering 238% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

Like most companies, Aritzia does come with some risks, and we've found 1 warning sign that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.