Investors Shouldn't Overlook Aritzia's (TSE:ATZ) Impressive Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in Aritzia's (TSE:ATZ) returns on capital, so let's have 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. To calculate this metric for Aritzia, this is the formula:

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

0.25 = CA$267m ÷ (CA$1.5b - CA$450m) (Based on the trailing twelve months to August 2022).

Therefore, Aritzia has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 18%.

Our analysis indicates that ATZ is potentially undervalued!

In the above chart we have measured Aritzia's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

The trends we've noticed at Aritzia are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 25%. Basically the business is earning more per dollar of capital invested and in addition to that, 158% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 30% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. 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...

To sum it up, Aritzia has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And a remarkable 336% total return over the last five years tells us that investors are expecting more good things to come in the future. In light of that, we think it's worth looking further into this stock because if Aritzia can keep these trends up, it could have a bright future ahead.

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

Aritzia 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.