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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, 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. With that in mind, we've noticed some promising trends at Kirkland's (NASDAQ:KIRK) so let's look a bit deeper.
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. To calculate this metric for Kirkland's, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$26m ÷ (US$331m - US$135m) (Based on the trailing twelve months to January 2022).
So, Kirkland's has an ROCE of 13%. In absolute terms, that's a pretty standard return but compared to the Specialty Retail industry average it falls behind.
Above you can see how the current ROCE for Kirkland's 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 Kirkland's' ROCE Trend?
Kirkland's has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 54% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 41% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
The Bottom Line On Kirkland's' ROCE
As discussed above, Kirkland's appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Given the stock has declined 35% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.
One final note, you should learn about the 4 warning signs we've spotted with Kirkland's (including 1 which is a bit concerning) .
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.