What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Dollarama (TSE:DOL), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

Return On Capital Employed (ROCE): What Is It?

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. To calculate this metric for Dollarama, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.34 = CA$1.1b ÷ (CA$4.4b - CA$1.2b) (Based on the trailing twelve months to July 2022).

Therefore, Dollarama has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 13%.

See our latest analysis for Dollarama

In the above chart we have measured Dollarama's 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 The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 44% five years ago, while the business's capital employed increased by 95%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. Dollarama probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, Dollarama's current liabilities have increased over the last five years to 28% of total assets, effectively distorting the ROCE to some degree. 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

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Dollarama. And the stock has followed suit returning a meaningful 80% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

If you'd like to know more about Dollarama, we've spotted 2 warning signs, and 1 of them is a bit concerning.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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