REA Group (ASX:REA) Knows How To Allocate Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of REA Group (ASX:REA) looks attractive right now, so lets see what the trend of returns can tell us.

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)

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

Thus, REA Group has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 8.8%.

View 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, you can check out the forecasts from the analysts covering REA Group here for free.

What The Trend Of ROCE Can Tell Us

REA Group deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 25% and the business has deployed 75% more capital into its operations. 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.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 11% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line

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 70% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.

While REA Group looks impressive, no company is worth an infinite price. The intrinsic value infographic in our free research report helps visualize whether REA is currently trading for a fair price.

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.