If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So, when we ran our eye over REA Group's (ASX:REA) trend of ROCE, we really liked what we saw.
Understanding 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 REA Group:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = AU$527m ÷ (AU$2.4b - AU$290m) (Based on the trailing twelve months to December 2021).
Thus, REA Group has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 9.0%.
Above you can see how the current ROCE for REA Group 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 REA Group here for free.
What The Trend Of ROCE Can Tell Us
We'd be pretty happy with returns on capital like REA Group. The company has employed 56% more capital in the last five years, and the returns on that capital have remained stable at 25%. Now considering ROCE is an attractive 25%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. You'll see this when looking at well operated businesses or favorable business models.
Our Take On REA Group's ROCE
REA Group has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. Therefore it's no surprise that shareholders have earned a respectable 95% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Before jumping to any conclusions though, we need to know what value we're getting for the current share price. That's where you can check out our FREE intrinsic value estimation that compares the share price and estimated value.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
Valuation is complex, but we're helping make it simple.
Find out whether REA Group is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis