Dollarama (TSE:DOL) Could Be Struggling To Allocate Capital

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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, while the ROCE is currently high for Dollarama (TSE:DOL), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

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 Dollarama, this is the formula:

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

0.31 = CA$1.2b ÷ (CA$5.0b - CA$1.1b) (Based on the trailing twelve months to April 2023).

So, Dollarama has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 12%.

See our latest analysis for Dollarama

In the above chart we have measured Dollarama'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 Dollarama here for free.

What The Trend Of ROCE Can Tell Us

Unfortunately, the trend isn't great with ROCE falling from 54% five years ago, while capital employed has grown 168%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Dollarama 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.

What We Can Learn From Dollarama's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Dollarama is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 80% over the last five years, it would appear that investors are upbeat about the future. So should these growth trends continue, we'd be optimistic on the stock going forward.

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

Dollarama 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.