If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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 Urban Outfitters (NASDAQ:URBN) 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. To calculate this metric for Urban Outfitters, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$357m ÷ (US$4.1b - US$1.0b) (Based on the trailing twelve months to October 2023).
Therefore, Urban Outfitters has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 13% generated by the Specialty Retail industry.
In the above chart we have measured Urban Outfitters' 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 Urban Outfitters for free.
How Are Returns Trending?
When we looked at the ROCE trend at Urban Outfitters, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 12% from 21% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.
In Conclusion...
Bringing it all together, while we're somewhat encouraged by Urban Outfitters' reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 40% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.
If you're still interested in Urban Outfitters it's worth checking out our FREE intrinsic value approximation for URBN to see if it's trading at an attractive price in other respects.
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.
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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.