If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. So while NEXT (LON:NXT) has a high ROCE right now, lets see what we can decipher from how returns are changing.
What Is 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. Analysts use this formula to calculate it for NEXT:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.32 = UK£882m ÷ (UK£4.0b - UK£1.2b) (Based on the trailing twelve months to January 2022).
Thus, NEXT has an ROCE of 32%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 17%.
Check out our latest analysis for NEXT
Above you can see how the current ROCE for NEXT compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is NEXT's ROCE Trending?
When we looked at the ROCE trend at NEXT, we didn't gain much confidence. Historically returns on capital were even higher at 49%, but they have dropped over the last five years. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
In Conclusion...
In summary, despite lower returns in the short term, we're encouraged to see that NEXT is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 58% to shareholders over the last five years. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
NEXT does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is potentially serious...
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.