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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Ulta Beauty (NASDAQ:ULTA) and its ROCE trend, we weren't exactly thrilled.
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 Ulta Beauty, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.096 = US$427m ÷ (US$5.5b - US$1.1b) (Based on the trailing twelve months to August 2020).
Therefore, Ulta Beauty has an ROCE of 9.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.7%.
Above you can see how the current ROCE for Ulta Beauty 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 Ulta Beauty here for free.
So How Is Ulta Beauty's ROCE Trending?
In terms of Ulta Beauty's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 26% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On Ulta Beauty's ROCE
To conclude, we've found that Ulta Beauty is reinvesting in the business, but returns have been falling. Unsurprisingly, the stock has only gained 37% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you want to continue researching Ulta Beauty, you might be interested to know about the 3 warning signs that our analysis has discovered.
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.
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.
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