Returns On Capital Are Showing Encouraging Signs At AO World (LON:AO.)

If you're looking for a multi-bagger, there's a few things to keep an eye out for. 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. So on that note, AO World (LON:AO.) looks quite promising in regards to its trends of return on capital.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested 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)

0.15 = UK£26m ÷ (UK£585m - UK£405m) (Based on the trailing twelve months to September 2020).

Thus, AO World has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 16% generated by the Online Retail industry.

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What Can We Tell From AO World's ROCE Trend?

We're delighted to see that AO World is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 15% on its capital. In addition to that, AO World is employing 215% more capital than previously which is expected of a company that's trying to break into profitability. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

Another thing to note, AO World has a high ratio of current liabilities to total assets of 69%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. 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. Since the stock has returned a solid 65% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

If you'd like to know about the risks facing AO World, we've discovered 1 warning sign that you should be aware of.

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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