To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Kirkland's (NASDAQ:KIRK) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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 Kirkland's:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.071 = US$18m ÷ (US$387m - US$138m) (Based on the trailing twelve months to January 2021).
Thus, Kirkland's has an ROCE of 7.1%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.
Above you can see how the current ROCE for Kirkland's compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Kirkland's.
How Are Returns Trending?
On the surface, the trend of ROCE at Kirkland's doesn't inspire confidence. Over the last five years, returns on capital have decreased to 7.1% from 15% five years ago. Given the business is employing more capital while revenue has slipped, this is a bit concerning. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 36%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
The Key Takeaway
In summary, we're somewhat concerned by Kirkland's' diminishing returns on increasing amounts of capital. However the stock has delivered a 68% return to shareholders over the last five years, so investors might be expecting the trends to turn around. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
On a final note, we've found 4 warning signs for Kirkland's that we think you should be aware of.
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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