Returns On Capital Are Showing Encouraging Signs At Lovesac (NASDAQ:LOVE)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Lovesac (NASDAQ:LOVE) looks quite promising in regards to its trends of return on capital.

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. Analysts use this formula to calculate it for Lovesac:

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

0.12 = US$39m ÷ (US$418m - US$89m) (Based on the trailing twelve months to January 2023).

Therefore, Lovesac has an ROCE of 12%. In absolute terms, that's a pretty standard return but compared to the Consumer Durables industry average it falls behind.

See our latest analysis for Lovesac

Above you can see how the current ROCE for Lovesac 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 Lovesac here for free.

How Are Returns Trending?

The fact that Lovesac is now generating some pre-tax profits from its prior investments is very encouraging. About five years ago the company was generating losses but things have turned around because it's now earning 12% on its capital. Not only that, but the company is utilizing 1,250% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

One more thing to note, Lovesac has decreased current liabilities to 21% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Key Takeaway

To the delight of most shareholders, Lovesac has now broken into profitability. And with the stock having performed exceptionally well over the last three years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

One more thing: We've identified 2 warning signs with Lovesac (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.