What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating DFS Furniture (LON:DFS), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
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 DFS Furniture, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.046 = UK£33m ÷ (UK£1.1b - UK£376m) (Based on the trailing twelve months to December 2020).
Therefore, DFS Furniture has an ROCE of 4.6%. Ultimately, that's a low return and it under-performs the Consumer Durables industry average of 6.8%.
Above you can see how the current ROCE for DFS Furniture compares to its prior returns on capital, but there's only so much you can tell from the past. 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 DFS Furniture's ROCE Trend?
The trend of ROCE doesn't look fantastic because it's fallen from 15% five years ago, while the business's capital employed increased by 44%. Usually this isn't ideal, but given DFS Furniture conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. DFS Furniture 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. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
We're a bit apprehensive about DFS Furniture because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 17% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
While DFS Furniture doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
While DFS Furniture isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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.
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