Alphabet (NASDAQ:GOOGL) Is Very Good At Capital Allocation

What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. So when we looked at the ROCE trend of Alphabet (NASDAQ:GOOGL) we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. Analysts use this formula to calculate it for Alphabet:

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

0.30 = US$102b ÷ (US$415b - US$78b) (Based on the trailing twelve months to June 2024).

Therefore, Alphabet has an ROCE of 30%. That's a fantastic return and not only that, it outpaces the average of 6.6% earned by companies in a similar industry.

See our latest analysis for Alphabet

Above you can see how the current ROCE for Alphabet compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Alphabet for free.

How Are Returns Trending?

The trends we've noticed at Alphabet are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 30%. The amount of capital employed has increased too, by 53%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

The Bottom Line

To sum it up, Alphabet has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

While Alphabet looks impressive, no company is worth an infinite price. The intrinsic value infographic for GOOGL helps visualize whether it is currently trading for a fair price.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high 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.