The Returns At Children's Place (NASDAQ:PLCE) Aren't Growing

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Having said that, while the ROCE is currently high for Children's Place (NASDAQ:PLCE), we aren't jumping out of our chairs because returns are decreasing.

Understanding Return On Capital Employed (ROCE)

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. Analysts use this formula to calculate it for Children's Place:

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

0.32 = US$128m ÷ (US$1.1b - US$684m) (Based on the trailing twelve months to October 2022).

So, Children's Place has an ROCE of 32%. That's a fantastic return and not only that, it outpaces the average of 17% earned by companies in a similar industry.

Check out our latest analysis for Children's Place

Above you can see how the current ROCE for Children's Place compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Children's Place here for free.

So How Is Children's Place's ROCE Trending?

We're a bit concerned with the trends, because the business is applying 31% less capital than it was five years ago and returns on that capital have stayed flat. When a company effectively decreases its assets base, it's not usually a sign to be optimistic on that company. But we have to give it to Children's Place because the returns on the capital it is employing are still high in relative terms.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 63% of total assets, this reported ROCE would probably be less than32% because total capital employed would be higher.The 32% ROCE could be even lower if current liabilities weren't 63% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

The Bottom Line

It's a shame to see that Children's Place is effectively shrinking in terms of its capital base. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 72% in the last five years. Therefore based on the analysis done in this article, we don't think Children's Place has the makings of a multi-bagger.

If you want to know some of the risks facing Children's Place we've found 2 warning signs (1 makes us a bit uncomfortable!) that you should be aware of before investing here.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.

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