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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Big 5 Sporting Goods' (NASDAQ:BGFV) returns on capital, so let's have a look.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Big 5 Sporting Goods is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.27 = US$137m ÷ (US$745m - US$240m) (Based on the trailing twelve months to October 2021).
Therefore, Big 5 Sporting Goods has an ROCE of 27%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 20%.
In the above chart we have measured Big 5 Sporting Goods' 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.
How Are Returns Trending?
The trends we've noticed at Big 5 Sporting Goods are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 27%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 101%. So we're very much inspired by what we're seeing at Big 5 Sporting Goods thanks to its ability to profitably reinvest capital.
In Conclusion...
To sum it up, Big 5 Sporting Goods has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 72% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing, we've spotted 4 warning signs facing Big 5 Sporting Goods that you might find interesting.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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