Mothercare (LON:MTC) Is Very Good At Capital Allocation

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. And in light of that, the trends we're seeing at Mothercare's (LON:MTC) look very promising so lets take a look.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Mothercare is:

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

0.49 = UK£11m ÷ (UK£34m - UK£12m) (Based on the trailing twelve months to September 2022).

Thus, Mothercare has an ROCE of 49%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 15%.

Check out our latest analysis for Mothercare

Above you can see how the current ROCE for Mothercare compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Mothercare here for free.

How Are Returns Trending?

You'd find it hard not to be impressed with the ROCE trend at Mothercare. We found that the returns on capital employed over the last five years have risen by 718%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Interestingly, the business may be becoming more efficient because it's applying 90% less capital than it was five years ago. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.

In Conclusion...

In summary, it's great to see that Mothercare has been able to turn things around and earn higher returns on lower amounts of capital. Given the stock has declined 41% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

Like most companies, Mothercare does come with some risks, and we've found 3 warning signs that you should be aware of.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.