Investors Shouldn't Overlook The Favourable Returns On Capital At REA Group (ASX:REA)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. That's why when we briefly looked at REA Group's (ASX:REA) ROCE trend, we were very happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for REA Group, this is the formula:

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

0.25 = AU$549m ÷ (AU$2.5b - AU$278m) (Based on the trailing twelve months to December 2022).

Thus, REA Group has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.

See our latest analysis for REA Group

In the above chart we have measured REA Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for REA Group.

What The Trend Of ROCE Can Tell Us

It's hard not to be impressed by REA Group's returns on capital. The company has employed 75% more capital in the last five years, and the returns on that capital have remained stable at 25%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a side note, REA Group has done well to reduce current liabilities to 11% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

Our Take On REA Group's ROCE

In short, we'd argue REA Group has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. Therefore it's no surprise that shareholders have earned a respectable 62% 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.

REA Group is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.