Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Shoe Zone (LON:SHOE) looks attractive right now, so lets see what the trend of returns can tell us.
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 Shoe Zone, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.21 = UK£12m ÷ (UK£98m - UK£41m) (Based on the trailing twelve months to October 2021).
So, Shoe Zone has an ROCE of 21%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 15%.
Above you can see how the current ROCE for Shoe Zone 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 Shoe Zone.
The Trend Of ROCE
Shoe Zone deserves to be commended in regards to it's returns. The company has consistently earned 21% for the last five years, and the capital employed within the business has risen 26% in that time. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
Another thing to note, Shoe Zone has a high ratio of current liabilities to total assets of 42%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
In summary, we're delighted to see that Shoe Zone has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And given the stock has only risen 12% over the last five years, we'd suspect the market is beginning to recognize these trends. That's why it could be worth your time looking into this stock further to discover if it has more traits of a multi-bagger.
On a final note, we found 2 warning signs for Shoe Zone (1 makes us a bit uncomfortable) 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.
Valuation is complex, but we're helping make it simple.
Find out whether Shoe Zone is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.