There are a few key trends to look for if we want to identify the next multi-bagger. 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Frontier Developments (LON:FDEV) looks decent, right now, so lets see what the trend of returns can tell us.
Understanding Return On Capital Employed (ROCE)
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 Frontier Developments, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = UK£19m ÷ (UK£145m - UK£16m) (Based on the trailing twelve months to November 2020).
Therefore, Frontier Developments has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 14% generated by the Entertainment industry.
Above you can see how the current ROCE for Frontier Developments compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Frontier Developments.
So How Is Frontier Developments' ROCE Trending?
While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 15% and the business has deployed 453% more capital into its operations. Since 15% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
What We Can Learn From Frontier Developments' ROCE
The main thing to remember is that Frontier Developments has proven its ability to continually reinvest at respectable rates of return. And long term investors would be thrilled with the 1,135% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
On a final note, we've found 1 warning sign for Frontier Developments that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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