Here's What Costco Wholesale's (NASDAQ:COST) Strong Returns On Capital Mean

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Ergo, when we looked at the ROCE trends at Costco Wholesale (NASDAQ:COST), we liked what we saw.

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. The formula for this calculation on Costco Wholesale is:

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

0.23 = US$7.9b ÷ (US$67b - US$33b) (Based on the trailing twelve months to February 2023).

Thus, Costco Wholesale has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Consumer Retailing industry average of 11%.

See our latest analysis for Costco Wholesale

In the above chart we have measured Costco Wholesale'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 Costco Wholesale.

So How Is Costco Wholesale's ROCE Trending?

Costco Wholesale deserves to be commended in regards to it's returns. The company has employed 74% more capital in the last five years, and the returns on that capital have remained stable at 23%. Now considering ROCE is an attractive 23%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.

On a separate but related note, it's important to know that Costco Wholesale has a current liabilities to total assets ratio of 49%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Key Takeaway

In summary, we're delighted to see that Costco Wholesale has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 173% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

On a separate note, we've found 1 warning sign for Costco Wholesale you'll probably want to know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks 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.