If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Tokyo Lifestyle (NASDAQ:TKLF) 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 Tokyo Lifestyle is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.11 = US$5.1m ÷ (US$142m - US$93m) (Based on the trailing twelve months to March 2024).

Thus, Tokyo Lifestyle has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 12%.

Historical performance is a great place to start when researching a stock so above you can see the gauge for Tokyo Lifestyle's ROCE against it's prior returns. If you'd like to look at how Tokyo Lifestyle has performed in the past in other metrics, you can view this free graph of Tokyo Lifestyle's past earnings, revenue and cash flow.

So How Is Tokyo Lifestyle's ROCE Trending?

We weren't thrilled with the trend because Tokyo Lifestyle's ROCE has reduced by 73% over the last five years, while the business employed 159% more capital. Usually this isn't ideal, but given Tokyo Lifestyle conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. Tokyo Lifestyle probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

Another thing to note, Tokyo Lifestyle has a high ratio of current liabilities to total assets of 66%. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

Our Take On Tokyo Lifestyle's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Tokyo Lifestyle is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 384% to shareholders in the last year. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

One more thing: We've identified 5 warning signs with Tokyo Lifestyle (at least 3 which are a bit concerning) , and understanding them would certainly be useful.

While Tokyo Lifestyle isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.