To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of CarGurus (NASDAQ:CARG) looks decent, right now, so lets see what the trend of returns can tell us.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on CarGurus is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$150m ÷ (US$946m - US$149m) (Based on the trailing twelve months to March 2022).
Therefore, CarGurus has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Interactive Media and Services industry average of 4.4% it's much better.
In the above chart we have measured CarGurus' 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 CarGurus.
So How Is CarGurus' ROCE Trending?
While the returns on capital are good, they haven't moved much. The company has employed 955% more capital in the last five years, and the returns on that capital have remained stable at 19%. 19% is a pretty standard return, and it provides some comfort knowing that CarGurus has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
On a side note, CarGurus has done well to reduce current liabilities to 16% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.
The Key Takeaway
The main thing to remember is that CarGurus has proven its ability to continually reinvest at respectable rates of return. However, despite the favorable fundamentals, the stock has fallen 33% over the last three years, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
CarGurus could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
What are the risks and opportunities for CarGurus?
Trading at 70.2% below our estimate of its fair value
Became profitable this year
Earnings are forecast to decline by an average of 12.9% per year for the next 3 years
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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.