This analysis is intended to introduce important early concepts to people who are starting to invest and want a simplistic look at the return on Facebook Inc (NASDAQ:FB) stock.
Buying Facebook makes you a partial owner of the company. As a result, your investment is being put to work to fund operations and if you want to earn an attractive return on your investment, the business needs to be making an adequate amount of money from the funds you provide. Your return is tied to FB’s ability to do this because the amount earned is used to invest in opportunities to grow the business or payout dividends, which are the two sources of return on investment. To understand Facebook’s capital returns we will look at a useful metric called return on capital employed. This will tell us if the company is growing your capital and placing you in good stead to sell your shares at a profit.
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Calculating Return On Capital Employed for FB
Choosing to invest in Facebook comes at the cost of investing in another potentially favourable company. The cost of missing out on another opportunity comes in the form of the potential long term gain you could’ve received, which is dependent on the gap between the return on capital you could’ve achieved and that of the company you invested in. Hence, capital returns are very important, and should be examined before you invest in conjunction with a certain benchmark that represents the minimum return you require to be compensated for the risk of missing out on other potentially lucrative investments. To determine Facebook’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). Take a look at the formula box beneath:
ROCE Calculation for FB
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$24.9b ÷ (US$92.5b – US$5.5b) = 29%
The calculation above shows that FB’s earnings were 29% of capital employed. A good ROCE hurdle you should aim for in your investments is 15%, which is exceeded by FB and means the company creates an excellent amount of earnings on capital employed. If this can be sustained with good reinvestment opportunities or dividend distributions your capital has the potential to compound extremely well over time.
Before moving forward
Facebook’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Facebook is in a favourable position, but this can change if these factors underperform. So it is important for investors to understand what is going on under the hood and look at how these variables have been behaving. If you go back three years, you’ll find that FB’s ROCE has increased from 11%. With this, the current earnings of US$24.9b improved from US$4.7b and capital employed also increased but to a smaller extent, which means the company has been able to improve ROCE by driving up earnings relative to the capital invested in the business.
Next Steps
FB’s investors have enjoyed an upward trend in ROCE and it is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. This is an ideal situation to be in, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. If you don’t pay attention to these factors you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. Facebook’s fundamentals can be explored with the links I’ve provided below if you are interested, otherwise you can start looking at other high-performing stocks.
- Future Outlook: What are well-informed industry analysts predicting for FB’s future growth? Take a look at our free research report of analyst consensus for FB’s outlook.
- Valuation: What is FB worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether FB is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.