If you’re looking for a multi-bagger, there’s a few things to keep an eye out for. Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 PriceSmart (NASDAQ:PSMT) and its ROCE trend, we weren’t exactly thrilled.
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 PriceSmart is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = US$123m ÷ (US$1.7b – US$568m) (Based on the trailing twelve months to August 2020).
Thus, PriceSmart has an ROCE of 11%. By itself that’s a normal return on capital and it’s in line with the industry’s average returns of 11%.
In the above chart we have measured PriceSmart’s prior ROCE against its prior performance, but the future is arguably more important. If you’d like, you can check out the forecasts from the analysts covering PriceSmart here for free.
What Does the ROCE Trend For PriceSmart Tell Us?
On the surface, the trend of ROCE at PriceSmart doesn’t inspire confidence. To be more specific, ROCE has fallen from 23% over the last five years. However it looks like PriceSmart might be reinvesting for long term growth because while capital employed has increased, the company’s sales haven’t changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
Bringing it all together, while we’re somewhat encouraged by PriceSmart’s reinvestment in its own business, we’re aware that returns are shrinking. Since the stock has declined 22% over the last five years, investors may not be too optimistic on this trend improving either. On the whole, we aren’t too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
One more thing to note, we’ve identified 1 warning sign with PriceSmart and understanding this should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.