Investors Will Want AO World's (LON:AO.) Growth In ROCE To Persist

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. With that in mind, we've noticed some promising trends at AO World (LON:AO.) so let's look a bit deeper.

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. Analysts use this formula to calculate it for AO World:

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

0.027 = UK£4.8m ÷ (UK£546m - UK£371m) (Based on the trailing twelve months to September 2021).

So, AO World has an ROCE of 2.7%. Ultimately, that's a low return and it under-performs the Online Retail industry average of 13%.

See our latest analysis for AO World

Above you can see how the current ROCE for AO World compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering AO World here for free.

So How Is AO World's ROCE Trending?

We're delighted to see that AO World is reaping rewards from its investments and is now generating some pre-tax profits. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 2.7% on its capital. In addition to that, AO World is employing 200% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

Another thing to note, AO World has a high ratio of current liabilities to total assets of 68%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

In summary, it's great to see that AO World has managed to break into profitability and is continuing to reinvest in its business. And since the stock has fallen 39% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

One more thing to note, we've identified 1 warning sign with AO World and understanding this should be part of your investment process.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.