Why The 22% Return On Capital At CarGurus (NASDAQ:CARG) Should Have Your Attention

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Speaking of which, we noticed some great changes in CarGurus' (NASDAQ:CARG) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for CarGurus, this is the formula:

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

0.22 = US$149m ÷ (US$784m - US$104m) (Based on the trailing twelve months to June 2021).

So, CarGurus has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 9.2% earned by companies in a similar industry.

Check out our latest analysis for CarGurus

Above you can see how the current ROCE for CarGurus compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for CarGurus.

The Trend Of ROCE

Investors would be pleased with what's happening at CarGurus. Over the last five years, returns on capital employed have risen substantially to 22%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 926%. So we're very much inspired by what we're seeing at CarGurus thanks to its ability to profitably reinvest capital.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 13%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Bottom Line

To sum it up, CarGurus has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Astute investors may have an opportunity here because the stock has declined 40% in the last three years. With that in mind, we believe the promising trends warrant this stock for further investigation.

Like most companies, CarGurus does come with some risks, and we've found 2 warning signs that you should be aware of.

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. 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.
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