Ross Stores (NASDAQ:ROST) May Have Issues Allocating Its Capital

What are the early trends we should look for to identify a stock that could 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. So when we looked at Ross Stores (NASDAQ:ROST), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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. The formula for this calculation on Ross Stores is:

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

0.20 = US$2.0b ÷ (US$14b - US$4.0b) (Based on the trailing twelve months to July 2023).

Thus, Ross Stores has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 13%.

Check out our latest analysis for Ross Stores

In the above chart we have measured Ross Stores' prior ROCE against its prior performance, but the future is arguably more important. 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 Ross Stores' ROCE Trend?

When we looked at the ROCE trend at Ross Stores, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 53%. However it looks like Ross Stores might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Ross Stores' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 30% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Ross Stores does have some risks though, and we've spotted 1 warning sign for Ross Stores that you might be interested in.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.