To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating Sally Beauty Holdings (NYSE:SBH), we don't think it's current trends fit the mold of a multi-bagger.
Return On Capital Employed (ROCE): What is it?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Sally Beauty Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$329m ÷ (US$2.9b - US$875m) (Based on the trailing twelve months to March 2021).
Thus, Sally Beauty Holdings has an ROCE of 16%. By itself that's a normal return on capital and it's in line with the industry's average returns of 16%.NYSE:SBH Return on Capital Employed July 27th 2021
In the above chart we have measured Sally Beauty Holdings' 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 Sally Beauty Holdings here for free.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Sally Beauty Holdings, we didn't gain much confidence. Around five years ago the returns on capital were 33%, but since then they've fallen to 16%. 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.
What We Can Learn From Sally Beauty Holdings' ROCE
In summary, Sally Beauty Holdings is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors appear hesitant that the trends will pick up because the stock has fallen 22% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.
Like most companies, Sally Beauty Holdings does come with some risks, and we've found 1 warning sign that you should be aware of.
While Sally Beauty Holdings 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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