Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Five Below (NASDAQ:FIVE), it didn't seem to tick all of these boxes.
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 Five Below is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$362m ÷ (US$4.0b - US$685m) (Based on the trailing twelve months to August 2024).
Thus, Five Below has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 12% generated by the Specialty Retail industry.
In the above chart we have measured Five Below's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Five Below .
What Does the ROCE Trend For Five Below Tell Us?
When we looked at the ROCE trend at Five Below, we didn't gain much confidence. To be more specific, ROCE has fallen from 14% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line On Five Below's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Five Below is reinvesting for growth and has higher sales as a result. These growth trends haven't led to growth returns though, since the stock has fallen 33% over the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.
One more thing to note, we've identified 1 warning sign with Five Below and understanding this should be part of your investment process.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
