If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Nick Scali (ASX:NCK), it does have a high ROCE right now, but lets see how returns are trending.

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 Nick Scali is:

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

0.32 = AU$152m ÷ (AU$608m - AU$134m) (Based on the trailing twelve months to June 2023).

Thus, Nick Scali has an ROCE of 32%.  That's a fantastic return and not only that, it outpaces the average of 19% earned by companies in a similar industry.

Check out our latest analysis for Nick Scali  roce

In the above chart we have measured Nick Scali's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our freereport for Nick Scali.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Nick Scali doesn't inspire confidence. While it's comforting that the ROCE is high, five years ago it was 56%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, Nick Scali has decreased its current liabilities to 22% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.



What We Can Learn From Nick Scali's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Nick Scali. And the stock has done incredibly well with a 198% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

If you'd like to know about the risks facing Nick Scali, we've discovered 1 warning sign that you should be aware of.

Nick Scali is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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.