British American Tobacco (LON:BATS) Is Looking To Continue Growing Its Returns On 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at British American Tobacco (LON:BATS) and its trend of ROCE, we really liked what we saw.

Understanding 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 British American Tobacco is:

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

0.12 = UK£13b ÷ (UK£119b - UK£16b) (Based on the trailing twelve months to December 2023).

So, British American Tobacco has an ROCE of 12%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Tobacco industry average of 14%.

See our latest analysis for British American Tobacco

In the above chart we have measured British American Tobacco'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 British American Tobacco for free.

How Are Returns Trending?

British American Tobacco has not disappointed in regards to ROCE growth. We found that the returns on capital employed over the last five years have risen by 59%. That's not bad because this tells for every dollar invested (capital employed), the company is increasing the amount earned from that dollar. Speaking of capital employed, the company is actually utilizing 21% less than it was five years ago, which can be indicative of a business that's improving its efficiency. A business that's shrinking its asset base like this isn't usually typical of a soon to be multi-bagger company.

What We Can Learn From British American Tobacco's ROCE

In a nutshell, we're pleased to see that British American Tobacco has been able to generate higher returns from less capital. Considering the stock has delivered 9.2% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.

Like most companies, British American Tobacco does come with some risks, and we've found 2 warning signs that you should be aware of.

While British American Tobacco isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.