Ulta Beauty (NASDAQ:ULTA) Might Become A Compounding Machine

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. Ergo, when we looked at the ROCE trends at Ulta Beauty (NASDAQ:ULTA), we liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Ulta Beauty:

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

0.31 = US$1.1b ÷ (US$5.0b - US$1.4b) (Based on the trailing twelve months to July 2021).

So, Ulta Beauty has an ROCE of 31%. That's a fantastic return and not only that, it outpaces the average of 17% earned by companies in a similar industry.

See our latest analysis for Ulta Beauty

In the above chart we have measured Ulta Beauty's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Ulta Beauty.

What The Trend Of ROCE Can Tell Us

It's hard not to be impressed by Ulta Beauty's returns on capital. The company has consistently earned 31% for the last five years, and the capital employed within the business has risen 97% 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.

The Bottom Line

In summary, we're delighted to see that Ulta Beauty has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

One more thing to note, we've identified 1 warning sign with Ulta Beauty and understanding it should be part of your investment process.

Ulta Beauty is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.
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