There Are Reasons To Feel Uneasy About Indigo Books & Music's (TSE:IDG) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Although, when we looked at Indigo Books & Music (TSE:IDG), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What is it?

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. Analysts use this formula to calculate it for Indigo Books & Music:

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

0.05 = CA$24m ÷ (CA$809m - CA$332m) (Based on the trailing twelve months to April 2022).

Thus, Indigo Books & Music has an ROCE of 5.0%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 18%.

View our latest analysis for Indigo Books & Music

In the above chart we have measured Indigo Books & Music'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.

What Can We Tell From Indigo Books & Music's ROCE Trend?

When we looked at the ROCE trend at Indigo Books & Music, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.0% from 6.5% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Indigo Books & Music's current liabilities are still rather high at 41% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Indigo Books & Music'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 Indigo Books & Music. But since the stock has dived 81% in the last five years, there could be other drivers that are influencing the business' outlook. Therefore, we'd suggest researching the stock further to uncover more about the business.

One more thing, we've spotted 3 warning signs facing Indigo Books & Music that you might find interesting.

While Indigo Books & Music may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.