The Return Trends At British American Tobacco (LON:BATS) Look Promising

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look 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. 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, British American Tobacco (LON:BATS) looks quite promising in regards to its trends of return on capital.

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

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for British American Tobacco, this is the formula:

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).

Thus, British American Tobacco has an ROCE of 12%. In isolation, that's a pretty standard return but against the Tobacco industry average of 17%, it's not as good.

View our latest analysis for British American Tobacco

Above you can see how the current ROCE for British American Tobacco 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 analyst report for British American Tobacco .

What The Trend Of ROCE Can Tell Us

You'd find it hard not to be impressed with the ROCE trend at British American Tobacco. The data shows that returns on capital have increased by 59% over the trailing five years. That's a very favorable trend because this means that the company is earning more per dollar of capital that's being employed. 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.

Our Take On British American Tobacco's ROCE

From what we've seen above, British American Tobacco has managed to increase it's returns on capital all the while reducing it's capital base. Considering the stock has delivered 28% 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. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

British American Tobacco does have some risks though, and we've spotted 2 warning signs for British American Tobacco that you might be interested in.

While British American Tobacco may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com