If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. 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 Sally Beauty Holdings (NYSE:SBH) and its ROCE trend, we weren't exactly thrilled.
What is 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 Sally Beauty Holdings, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$424m ÷ (US$2.8b - US$665m) (Based on the trailing twelve months to September 2021).
Therefore, Sally Beauty Holdings has an ROCE of 19%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 21%.
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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Sally Beauty Holdings Tell Us?
On the surface, the trend of ROCE at Sally Beauty Holdings doesn't inspire confidence. Over the last five years, returns on capital have decreased to 19% from 30% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
The Bottom Line On Sally Beauty Holdings' ROCE
While returns have fallen for Sally Beauty Holdings in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 31% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
If you'd like to know about the risks facing Sally Beauty Holdings, we've discovered 3 warning signs that you should be aware of.
While Sally Beauty Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
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