Investors Should Be Encouraged By AO World's (LON:AO.) Returns On Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. 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 the ROCE trend of AO World (LON:AO.) we really liked what we saw.

Our free stock report includes 1 warning sign investors should be aware of before investing in AO World. Read for free now.

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 AO World, this is the formula:

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

0.20 = UK£38m ÷ (UK£456m - UK£265m) (Based on the trailing twelve months to September 2024).

So, AO World has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

View our latest analysis for AO World

In the above chart we have measured AO World'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 analyst report for AO World .

What Does the ROCE Trend For AO World Tell Us?

AO World has broken into the black (profitability) and we're sure it's a sight for sore eyes. The company now earns 20% on its capital, because five years ago it was incurring losses. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. With no noticeable increase in capital employed, it's worth knowing what the company plans on doing going forward in regards to reinvesting and growing the business. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

On a separate but related note, it's important to know that AO World has a current liabilities to total assets ratio of 58%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line

To sum it up, AO World is collecting higher returns from the same amount of capital, and that's impressive. Since the total return from the stock has been almost flat over the last five years, there might be an opportunity here if the valuation looks good. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

One more thing, we've spotted 1 warning sign facing AO World that you might find interesting.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.