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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at Urban Outfitters (NASDAQ:URBN) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Urban Outfitters is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$292m ÷ (US$3.6b - US$892m) (Based on the trailing twelve months to April 2021).
Therefore, Urban Outfitters has an ROCE of 11%. In isolation, that's a pretty standard return but against the Specialty Retail industry average of 15%, it's not as good.
Above you can see how the current ROCE for Urban Outfitters compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Urban Outfitters.
The Trend Of ROCE
When we looked at the ROCE trend at Urban Outfitters, we didn't gain much confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 11%. However it looks like Urban Outfitters 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.
What We Can Learn From Urban Outfitters' ROCE
In summary, Urban Outfitters is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Since the stock has gained an impressive 44% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
On a separate note, we've found 1 warning sign for Urban Outfitters you'll probably want to know about.
While Urban Outfitters 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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