Investors Will Want Trainline's (LON:TRN) Growth In ROCE To Persist

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So on that note, Trainline (LON:TRN) looks quite promising in regards to its trends of return on capital.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for Trainline, this is the formula:

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

0.037 = UK£15m ÷ (UK£648m - UK£240m) (Based on the trailing twelve months to August 2022).

Thus, Trainline has an ROCE of 3.7%. In absolute terms, that's a low return and it also under-performs the Hospitality industry average of 6.8%.

View our latest analysis for Trainline

In the above chart we have measured Trainline's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

Like most people, we're pleased that Trainline is now generating some pretax earnings. While the business is profitable now, it used to be incurring losses on invested capital five years ago. At first glance, it seems the business is getting more proficient at generating returns, because over the same period, the amount of capital employed has reduced by 27%. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 37% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Bottom Line On Trainline's ROCE

In a nutshell, we're pleased to see that Trainline has been able to generate higher returns from less capital. Given the stock has declined 11% in the last three years, this could be a good investment if the valuation and other metrics are also appealing. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we've found 1 warning sign for Trainline that we think you should be aware of.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.

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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.