RH (NYSE:RH) Might Have The Makings Of A Multi-Bagger

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at RH (NYSE:RH) and its trend of ROCE, we really liked what we saw.

What Is 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 RH:

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

0.17 = US$731m ÷ (US$5.3b - US$886m) (Based on the trailing twelve months to January 2023).

Thus, RH has an ROCE of 17%. That's a relatively normal return on capital, and it's around the 14% generated by the Specialty Retail industry.

View our latest analysis for RH

Above you can see how the current ROCE for RH 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 RH here for free.

SWOT Analysis for RH

So How Is RH's ROCE Trending?

RH is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 17%. Basically the business is earning more per dollar of capital invested and in addition to that, 262% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

One more thing to note, RH has decreased current liabilities to 17% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

Our Take On RH's ROCE

In summary, it's great to see that RH can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 163% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.

If you'd like to know more about RH, we've spotted 2 warning signs, and 1 of them is concerning.

While RH may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.