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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at Arhaus' (NASDAQ:ARHS) ROCE trend, we were very happy with what we saw.
What Is 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. The formula for this calculation on Arhaus is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.26 = US$188m ÷ (US$1.1b - US$386m) (Based on the trailing twelve months to September 2023).
So, Arhaus has an ROCE of 26%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 12%.
Above you can see how the current ROCE for Arhaus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Arhaus here for free.
What Does the ROCE Trend For Arhaus Tell Us?
In terms of Arhaus' history of ROCE, it's quite impressive. The company has employed 521% more capital in the last three years, and the returns on that capital have remained stable at 26%. Now considering ROCE is an attractive 26%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
One more thing to note, even though ROCE has remained relatively flat over the last three years, the reduction in current liabilities to 35% of total assets, is good to see from a business owner's perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
The Bottom Line
In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. However, despite the favorable fundamentals, the stock has fallen 23% over the last year, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
Arhaus does come with some risks though, we found 2 warning signs in our investment analysis, and 1 of those is concerning...
Arhaus is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
