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To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Designer Brands (NYSE:DBI), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Designer Brands:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$234m ÷ (US$2.1b - US$757m) (Based on the trailing twelve months to April 2022).
So, Designer Brands has an ROCE of 18%. That's a pretty standard return and it's in line with the industry average of 18%.
View our latest analysis for Designer Brands
In the above chart we have measured Designer Brands' 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 Designer Brands.
How Are Returns Trending?
Things have been pretty stable at Designer Brands, with its capital employed and returns on that capital staying somewhat the same for the last five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Designer Brands to be a multi-bagger going forward.
Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 36% of total assets, this reported ROCE would probably be less than18% because total capital employed would be higher.The 18% ROCE could be even lower if current liabilities weren't 36% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
What We Can Learn From Designer Brands' ROCE
In summary, Designer Brands isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Since the stock has declined 13% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.