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. 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. However, after investigating Tiffany (NYSE:TIF), we don't think it's current trends fit the mold of a multi-bagger.
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. The formula for this calculation on Tiffany is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = US$375m ÷ (US$6.9b - US$1.3b) (Based on the trailing twelve months to July 2020).
Thus, Tiffany has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 9.6%.
In the above chart we have measured Tiffany'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.
So How Is Tiffany's ROCE Trending?
On the surface, the trend of ROCE at Tiffany doesn't inspire confidence. Over the last five years, returns on capital have decreased to 6.7% from 18% 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.
Our Take On Tiffany's ROCE
From the above analysis, we find it rather worrisome that returns on capital and sales for Tiffany have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these concerning fundamentals, the stock has performed strongly with a 61% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
One more thing to note, we've identified 3 warning signs with Tiffany and understanding them should be part of your investment process.
While Tiffany isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email firstname.lastname@example.org.