L'Oréal (EPA:OR) Knows How To Allocate Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in L'Oréal's (EPA:OR) returns on capital, so let's have a look.

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 L'Oréal:

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

0.22 = €7.5b ÷ (€47b - €14b) (Based on the trailing twelve months to December 2022).

Therefore, L'Oréal has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

See our latest analysis for L'Oréal

Above you can see how the current ROCE for L'Oréal compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is L'Oréal's ROCE Trending?

L'Oréal is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 22%. The amount of capital employed has increased too, by 27%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Bottom Line On L'Oréal's ROCE

All in all, it's terrific to see that L'Oréal is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. Therefore, we think it would be worth your time to check if these trends are going to continue.

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.

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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.