There's Been No Shortage Of Growth Recently For AO World's (LON:AO.) Returns On Capital

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Speaking of which, we noticed some great changes in AO World's (LON:AO.) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

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

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

0.094 = UK£17m ÷ (UK£460m - UK£279m) (Based on the trailing twelve months to March 2023).

Therefore, AO World has an ROCE of 9.4%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

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 report on analyst forecasts for the company.

How Are Returns 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 9.4% on its capital. Not only that, but the company is utilizing 91% more capital than before, but that's to be expected from a company trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

Another thing to note, AO World has a high ratio of current liabilities to total assets of 61%. 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.

What We Can Learn From AO World's ROCE

Overall, AO World gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Astute investors may have an opportunity here because the stock has declined 39% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, AO World does come with some risks, and we've found 1 warning sign that you should be aware of.

While AO World isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.