To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at Temple & Webster Group (ASX:TPW) so let's look a bit deeper.
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 Temple & Webster Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.078 = AU$10m ÷ (AU$191m - AU$60m) (Based on the trailing twelve months to June 2023).
So, Temple & Webster Group has an ROCE of 7.8%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 19%.
Above you can see how the current ROCE for Temple & Webster Group 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.
What The Trend Of ROCE Can Tell Us
The fact that Temple & Webster Group is now generating some pre-tax profits from its prior investments is very encouraging. The company was generating losses five years ago, but now it's earning 7.8% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Temple & Webster Group is utilizing 1,081% 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 31%, 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.
What We Can Learn From Temple & Webster Group's ROCE
In summary, it's great to see that Temple & Webster Group has managed to break into profitability and is continuing to reinvest in its business. Since the stock has returned a staggering 541% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
While Temple & Webster Group isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.