Yahoo Finance There Are Reasons To Feel Uneasy About Michael Hill International's (ASX:MHJ) Returns On Capital
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. In light of that, when we looked at Michael Hill International (ASX:MHJ) and its ROCE trend, we weren't exactly thrilled.
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 Michael Hill International:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = AU$28m ÷ (AU$542m - AU$182m) (Based on the trailing twelve months to December 2020).
Therefore, Michael Hill International has an ROCE of 7.7%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 20%.
See our latest analysis for Michael Hill International
In the above chart we have measured Michael Hill International's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Michael Hill International's ROCE Trending?
When we looked at the ROCE trend at Michael Hill International, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Bottom Line
From the above analysis, we find it rather worrisome that returns on capital and sales for Michael Hill International have fallen, meanwhile the business is employing more capital than it was five years ago. It should come as no surprise then that the stock has fallen 36% over the last three years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.
Like most companies, Michael Hill International does come with some risks, and we've found 1 warning sign that you should be aware of.
While Michael Hill International isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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.
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