To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Arhaus (NASDAQ:ARHS) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Arhaus:

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

0.14 = US$112m ÷ (US$1.2b - US$392m) (Based on the trailing twelve months to June 2024).

So, Arhaus has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 12% generated by the Specialty Retail industry.

In the above chart we have measured Arhaus' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Arhaus for free.

The Trend Of ROCE

Unfortunately, the trend isn't great with ROCE falling from 24% four years ago, while capital employed has grown 526%. Usually this isn't ideal, but given Arhaus conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Arhaus might not have received a full period of earnings contribution from it.

On a related note, Arhaus has decreased its current liabilities to 33% 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 Arhaus' ROCE

Bringing it all together, while we're somewhat encouraged by Arhaus' reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last year has been flat. Therefore based on the analysis done in this article, we don't think Arhaus has the makings of a multi-bagger.

On a separate note, we've found 1 warning sign for Arhaus you'll probably want to know about.

While Arhaus isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.