Returns On Capital At Dis-Chem Pharmacies (JSE:DCP) Paint A Concerning Picture

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. Looking at Dis-Chem Pharmacies (JSE:DCP), it does have a high ROCE right now, but lets see how returns are trending.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Dis-Chem Pharmacies, this is the formula:

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

0.28 = R1.9b ÷ (R15b - R8.3b) (Based on the trailing twelve months to August 2022).

Therefore, Dis-Chem Pharmacies has an ROCE of 28%. That's a fantastic return and not only that, it outpaces the average of 16% earned by companies in a similar industry.

View our latest analysis for Dis-Chem Pharmacies

Above you can see how the current ROCE for Dis-Chem Pharmacies 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 Dis-Chem Pharmacies here for free.

How Are Returns Trending?

In terms of Dis-Chem Pharmacies' historical ROCE movements, the trend isn't fantastic. To be more specific, while the ROCE is still high, it's fallen from 44% where it was five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Dis-Chem Pharmacies' current liabilities are still rather high at 55% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Dis-Chem Pharmacies' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Dis-Chem Pharmacies is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 4.8% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

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

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.