- Oops!Something went wrong.Please try again later.
There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Speaking of which, we noticed some great changes in Merchant House International's (ASX:MHI) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Merchant House International is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.44 = AU$12m ÷ (AU$45m - AU$19m) (Based on the trailing twelve months to March 2021).
So, Merchant House International has an ROCE of 44%. In absolute terms that's a great return and it's even better than the Luxury industry average of 8.7%.
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating Merchant House International's past further, check out this free graph of past earnings, revenue and cash flow.
What Can We Tell From Merchant House International's ROCE Trend?
We're pretty happy with how the ROCE has been trending at Merchant House International. The data shows that returns on capital have increased by 1,437% over the trailing five years. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. In regards to capital employed, Merchant House International appears to been achieving more with less, since the business is using 44% less capital to run its operation. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.
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 42% of the business, which is more than it was five years ago. And with current liabilities at those levels, that's pretty high.
The Bottom Line
In the end, Merchant House International has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has fallen 63% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
On a separate note, we've found 3 warning signs for Merchant House International you'll probably want to know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.