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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. Speaking of which, we noticed some great changes in Lovesac's (NASDAQ:LOVE) returns on capital, so let's have a look.
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. To calculate this metric for Lovesac, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$39m ÷ (US$367m - US$104m) (Based on the trailing twelve months to May 2022).
So, Lovesac has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 16% generated by the Consumer Durables industry.
Check out our latest analysis for Lovesac
In the above chart we have measured Lovesac's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
The fact that Lovesac is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 15% on its capital. And unsurprisingly, like most companies trying to break into the black, Lovesac is utilizing 1,928% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 28%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. 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.
The Key Takeaway
Overall, Lovesac gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a solid 44% to shareholders over the last three years, it's fair to say investors are beginning to recognize these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.