Returns On Capital At Dollarama (TSE:DOL) Paint A Concerning Picture

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. 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.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Dollarama:

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

0.30 = CA$1.4b ÷ (CA$5.7b - CA$1.2b) (Based on the trailing twelve months to October 2023).

Thus, Dollarama has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

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 Can We Tell From Dollarama's ROCE Trend?

We weren't thrilled with the trend because Dollarama's ROCE has reduced by 45% over the last five years, while the business employed 199% more capital. That being said, Dollarama raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Dollarama's earnings and if they change as a result from the capital raise.

What We Can Learn From Dollarama's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Dollarama. And the stock has done incredibly well with a 190% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

On a separate note, we've found 1 warning sign for Dollarama you'll probably want to know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.