- Oops!Something went wrong.Please try again later.
What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while Dollarama (TSE:DOL) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Dollarama, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = CA$873m ÷ (CA$4.0b - CA$559m) (Based on the trailing twelve months to October 2021).
So, Dollarama has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.
In the above chart we have measured Dollarama'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 Dollarama's ROCE Trending?
The trend of ROCE doesn't look fantastic because it's fallen from 44% five years ago, while the business's capital employed increased by 149%. That being said, Dollarama raised some capital prior to their latest results being released, so that could partly explain the increase in capital employed. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with Dollarama's earnings and if they change as a result from the capital raise. Also, we found that by looking at the company's latest EBIT, the figure is within 10% of the previous year's EBIT so you can basically assign the ROCE drop primarily to that capital raise.
On a related note, Dollarama has decreased its current liabilities to 14% of total assets. That could partly explain why the ROCE has dropped. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
Bringing it all together, while we're somewhat encouraged by Dollarama's reinvestment in its own business, we're aware that returns are shrinking. Although the market must be expecting these trends to improve because the stock has gained 89% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
Dollarama does have some risks though, and we've spotted 2 warning signs for Dollarama that you might be interested in.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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.