Sportsman's Warehouse Holdings (NASDAQ:SPWH) May Have Issues Allocating Its Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Having said that, from a first glance at Sportsman's Warehouse Holdings (NASDAQ:SPWH) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What Is Return On Capital Employed (ROCE)?

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. Analysts use this formula to calculate it for Sportsman's Warehouse Holdings:

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

0.029 = US$17m ÷ (US$996m - US$418m) (Based on the trailing twelve months to July 2023).

Therefore, Sportsman's Warehouse Holdings has an ROCE of 2.9%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

See our latest analysis for Sportsman's Warehouse Holdings

Above you can see how the current ROCE for Sportsman's Warehouse Holdings 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 Sportsman's Warehouse Holdings here for free.

The Trend Of ROCE

On the surface, the trend of ROCE at Sportsman's Warehouse Holdings doesn't inspire confidence. To be more specific, ROCE has fallen from 37% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

On a side note, Sportsman's Warehouse Holdings has done well to pay down its current liabilities to 42% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

The Bottom Line

In summary, we're somewhat concerned by Sportsman's Warehouse Holdings' diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 36% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 4 warning signs we've spotted with Sportsman's Warehouse Holdings (including 2 which are concerning) .

While Sportsman's Warehouse Holdings isn't earning the highest return, check out this free list of companies that are 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.