If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. 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 Rent-A-Center's (NASDAQ:RCII) returns on capital, so let's have a look.
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. Analysts use this formula to calculate it for Rent-A-Center:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$270m ÷ (US$1.7b - US$512m) (Based on the trailing twelve months to September 2020).
Thus, Rent-A-Center has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 10%.
See our latest analysis for Rent-A-Center
In the above chart we have measured Rent-A-Center's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Rent-A-Center.
The Trend Of ROCE
You'd find it hard not to be impressed with the ROCE trend at Rent-A-Center. The figures show that over the last five years, returns on capital have grown by 184%. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. Speaking of capital employed, the company is actually utilizing 54% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Effectively this means that suppliers or short-term creditors are now funding 31% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
The Bottom Line
From what we've seen above, Rent-A-Center has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has returned a staggering 121% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.