Returns on Capital Paint A Bright Future For AO World (LON:AO.)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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.

Return On Capital Employed (ROCE): What Is It?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on AO World is:

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

0.20 = UK£37m ÷ (UK£440m - UK£255m) (Based on the trailing twelve months to September 2023).

So, AO World has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

Check out 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 .

How Are Returns Trending?

AO World has recently broken into profitability so their prior investments seem to be paying off. The company was generating losses five years ago, but now it's earning 20% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, AO World is utilizing 123% more capital than it was five years ago. 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.

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 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.

The Key Takeaway

To the delight of most shareholders, AO World has now broken into profitability. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 40% to shareholders. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation for AO. on our platform that is definitely worth checking out.

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.