Baby Bunting Group (ASX:BBN) may struggle to allocate capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should be looking for? In a perfect world, we would like to see a company invest more capital in their business and ideally the returns from that capital also increase. Simply put, these types of businesses are slot machines, meaning they continually reinvest their profits at ever-higher rates of return. That said, at a first glance at group of baby bunting (ASX:BBN) we’re not jumping off our chairs on the yield trend, but taking a closer look.

Understanding return on capital employed (ROCE)

For those unaware, ROCE is a measure of a company’s annual pre-tax profit (yield), relative to the capital employed in the business. Analysts use this formula to calculate it for Baby Bunting Group:

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

0.12 = AU$26 million ÷ (AUD$301 million – AU$83 million) (Based on the last twelve months to June 2021).

So, Baby Bunting Group has a ROCE of 12%. In absolute terms, that’s a pretty standard return, but compared to the specialty retail industry average, it lags behind.

Check out our latest analysis for Baby Bunting Group

In the chart above, we measured Baby Bunting Group’s past ROCE against its past performance, but the future is arguably more important. If you’re interested, you can check out analyst forecasts in our free analyst forecast report for the company.

The ROCE trend

On the surface, the ROCE trend at Baby Bunting Group does not inspire confidence. To be more specific, ROCE has fallen by 16% over the past five years. However, given that capital employed and revenue have both increased, it appears that the company is currently continuing to grow, following short-term returns. And if the capital increase generates additional returns, the company, and therefore the shareholders, will benefit in the long term.

The story continues

The essentials on the ROCE of the Baby Bunting group

Even though capital returns have fallen in the short term, we think it’s promising that both revenue and capital employed have increased for Baby Bunting Group. And the stock has done incredibly well with a 160% return over the past five years, so long-term investors are no doubt pleased with this result. So if these growth trends continue, we would be optimistic about the stock going forward.

One more thing to note, we have identified 2 warning signs with Baby Bunting Group and understanding them should be part of your investment process.

If you want to look for strong companies with excellent earnings, check out this free list of companies with strong balance sheets and impressive returns on equity.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.