Investors Could Be Concerned With Dollarama's (TSE:DOL) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at Dollarama (TSE:DOL), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Understanding 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 Dollarama, this is the formula:

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

0.30 = CA$951m ÷ (CA$4.1b - CA$912m) (Based on the trailing twelve months to January 2022).

Thus, Dollarama has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

See our latest analysis for Dollarama

Above you can see how the current ROCE for Dollarama compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Dollarama.

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 48% five years ago, while capital employed has grown 133%. Usually this isn't ideal, but given Dollarama conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. 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. Additionally, we found that Dollarama's most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.

The Bottom Line

In summary, Dollarama 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 gained an impressive 88% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Dollarama does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those shouldn't be ignored...

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

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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.