First Advantage (NASDAQ:FA) Might Be Having Difficulty Using Its Capital Effectively

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after investigating First Advantage (NASDAQ:FA), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

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 First Advantage:

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

0.053 = US$94m ÷ (US$1.9b - US$101m) (Based on the trailing twelve months to December 2022).

Thus, First Advantage has an ROCE of 5.3%. In absolute terms, that's a low return and it also under-performs the Professional Services industry average of 12%.

View our latest analysis for First Advantage

In the above chart we have measured First Advantage's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for First Advantage.

SWOT Analysis for First Advantage

So How Is First Advantage's ROCE Trending?

On the surface, the trend of ROCE at First Advantage doesn't inspire confidence. Around three years ago the returns on capital were 20%, but since then they've fallen to 5.3%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

Our Take On First Advantage's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for First Advantage. And there could be an opportunity here if other metrics look good too, because the stock has declined 32% in the last year. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

While First Advantage doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

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.