Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So while Auto Trader Group (LON:AUTO) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Auto Trader Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.31 = UK£159m ÷ (UK£535m - UK£25m) (Based on the trailing twelve months to March 2021).
Therefore, Auto Trader Group has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 8.1%.
In the above chart we have measured Auto Trader Group'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 Auto Trader Group here for free.
How Are Returns Trending?
Unfortunately, the trend isn't great with ROCE falling from 49% five years ago, while capital employed has grown 47%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. It's unlikely that all of the funds raised have been put to work yet, so as a consequence Auto Trader Group might not have received a full period of earnings contribution from it.
The Bottom Line On Auto Trader Group's ROCE
In summary, we're somewhat concerned by Auto Trader Group's diminishing returns on increasing amounts of capital. Yet despite these concerning fundamentals, the stock has performed strongly with a 73% return over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.
If you're still interested in Auto Trader Group it's worth checking out our FREE intrinsic value approximation to see if it's trading at an attractive price in other respects.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.
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