Has REA Group (ASX:REA) Got What It Takes To Become A Multi-Bagger?

What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 looked at REA Group (ASX:REA), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on REA Group is:

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

0.31 = AU$414m ÷ (AU$1.7b - AU$415m) (Based on the trailing twelve months to December 2020).

Therefore, REA Group has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 13%.

View our latest analysis for REA Group

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 to see what analysts are forecasting going forward, you should check out our free report for REA Group.

What Does the ROCE Trend For REA Group Tell Us?

In terms of REA Group's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 45%. However it looks like REA Group might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, REA Group's current liabilities have increased over the last five years to 24% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 31%. Keep an eye on this ratio, because the business could encounter some new risks if this metric gets too high.

The Bottom Line

In summary, REA Group is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 166% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.

On a final note, we've found 2 warning signs for REA Group that we think you should be aware of.

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.

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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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