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If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Looking at Michael Hill International (ASX:MHJ), it does have a high ROCE right now, but lets see how returns are trending.
Return On Capital Employed (ROCE): What Is It?
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 Michael Hill International, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = AU$72m ÷ (AU$539m - AU$171m) (Based on the trailing twelve months to December 2021).
Thus, Michael Hill International has an ROCE of 20%. In absolute terms that's a very respectable return and compared to the Specialty Retail industry average of 19% it's pretty much on par.
Check out our latest analysis for Michael Hill International
Above you can see how the current ROCE for Michael Hill International 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 Michael Hill International here for free.
So How Is Michael Hill International's ROCE Trending?
Over the past five years, Michael Hill International's ROCE and capital employed have both remained mostly flat. 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. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward. On top of that you'll notice that Michael Hill International has been paying out a large portion (61%) of earnings in the form of dividends to shareholders. Most shareholders probably know this and own the stock for its dividend.
The Bottom Line On Michael Hill International's ROCE
In summary, Michael Hill International isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Unsurprisingly, the stock has only gained 12% over the last five years, which potentially indicates that investors are accounting for this going forward. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.