Should You Be Impressed By Target's (NYSE:TGT) Returns on Capital?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Target (NYSE:TGT) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Target:

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

0.16 = US$5.3b ÷ (US$48b - US$16b) (Based on the trailing twelve months to August 2020).

Thus, Target has an ROCE of 16%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Multiline Retail industry average of 15%.

Check out our latest analysis for Target

Above you can see how the current ROCE for Target compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Does the ROCE Trend For Target Tell Us?

Over the past five years, Target's ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. With that in mind, unless investment picks up again in the future, we wouldn't expect Target to be a multi-bagger going forward. With fewer investment opportunities, it makes sense that Target has been paying out a decent 37% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

The Key Takeaway

In summary, Target isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 148% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

If you want to continue researching Target, you might be interested to know about the 2 warning signs that our analysis has discovered.

While Target 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.

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