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There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So while Nick Scali (ASX:NCK) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Understanding 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 Nick Scali is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = AU$88m ÷ (AU$408m - AU$120m) (Based on the trailing twelve months to December 2020).
Therefore, Nick Scali has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 20%.
View our latest analysis for Nick Scali
Above you can see how the current ROCE for Nick Scali 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 Nick Scali here for free.
What Does the ROCE Trend For Nick Scali Tell Us?
On the surface, the trend of ROCE at Nick Scali doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 40%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
The Bottom Line On Nick Scali's ROCE
While returns have fallen for Nick Scali in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 228% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
One more thing: We've identified 2 warning signs with Nick Scali (at least 1 which is significant) , and understanding these would certainly be useful.
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.
This article by Simply Wall St is general in nature. 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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