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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? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, from a first glance at Card Factory (LON:CARD) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Card Factory, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = UK£71m ÷ (UK£598m - UK£105m) (Based on the trailing twelve months to July 2024).
Thus, Card Factory has an ROCE of 14%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 13%.
View our latest analysis for Card Factory
In the above chart we have measured Card Factory's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Card Factory for free.
What Does the ROCE Trend For Card Factory Tell Us?
Over the past five years, Card Factory's ROCE and capital employed have both remained mostly flat. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So don't be surprised if Card Factory doesn't end up being a multi-bagger in a few years time. This probably explains why Card Factory is paying out 38% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.
In Conclusion...
In summary, Card Factory isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Although the market must be expecting these trends to improve because the stock has gained 84% over the last five years. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.