Are the high returns from Dollarama Inc. (TSE: DOL) really that good?

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Today we're going to look at Dollarama Inc. (TSE: DOL) and think about its potential as an investment. In particular, we will take the return on capital employed (ROCE) into account, as it can be used to derive how profitably the company can use capital in its business.

First, we'll look at what ROCE is and how we calculate it. Then we compare the ROCE with similar companies. Last but not least, we will examine the impact that current liabilities have on ROCE.

Understanding Return on Investment (ROCE)

The ROCE is a measure that is used to assess how much (in percent) a company earns before investing in the capital invested in its business. If everything else is the same, a better deal has a higher ROCE. Ultimately, it's a useful but incomplete metric. The author Edwin Whiting points out that caution is required when comparing the ROCE of different companies, since “no two companies are exactly the same.

How do we calculate the ROCE?

The formula for calculating the return on investment is:

Return on investment = earnings before interest and taxes (EBIT) ÷ (total assets – current liabilities)

Or for Dollarama:

0.28 = CA $ 822 million (CA $ 3.7 billion – CA $ 803 million) (Based on the past twelve months to November 2019.)

So, Dollarama has a ROCE of 28%.

Check out our latest analysis for Dollarama

Does Dollarama have a good ROCE?

One way to evaluate ROCE is to compare similar companies. In our analysis, Dollarama's ROCE is well above the 11% average in the multiline retail industry. I think that's good to see as it implies that the company is better than other companies at getting the most out of their capital. Aside from industry comparison, Dollarama's ROCE is currently quite high in absolute terms.

Dollarama's current ROCE of 28% is lower than 3 years ago when the company reported a ROCE of 44%. We therefore ask ourselves whether the company is facing new challenges. The image below shows how Dollarama's ROCE compares to its industry, and you can click on it to learn more details about past growth.

TSX: DOL Past Revenue and Net Income, January 5, 2020
TSX: DOL Past Revenue and Net Income, January 5, 2020

Remember that this metric is backwards – it shows what happened in the past and does not predict the future exactly. The ROCE can be deceptive for cyclical companies, as yields can be unbelievable in booming times and terribly low in downturns. After all, ROCE is just a snapshot of a single year. What happens in the future is pretty important for investors free Analyst forecasts for Dollarama.

How Dollarama's current liabilities affect ROCE

Short-term (or short-term) liabilities are things like supplier bills, overdrafts or tax bills that must be paid within 12 months. The ROCE equation subtracts short-term debt from capital employed, so a company with many short-term liabilities appears to have less capital invested and a higher ROCE than usual. To check the impact, we calculate whether a company has high short-term liabilities in relation to its total assets.

Dollarama has total assets of CA $ 3.7 billion and short-term liabilities of CA $ 803 million. As a result, current liabilities are around 22% of total assets. A minimum amount of short-term liabilities limits the impact on ROCE.

The bottom line on Dollaramas ROCE

Low short-term debt and a high ROCE are a good combination that makes Dollarama very interesting. There could be better investments out there than Dollarama But you have to work hard to find them , These promising deals with fast growing result Maybe it's close to you.

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If you discover an error that justifies a correction, please contact the editorial team at editorial-team@simplywallst.com. This article from Simply Wall St is general in nature. It is not a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Simply Wall St has no position in the stocks mentioned.

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