If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Speaking of which, we noticed some great changes in Roku's (NASDAQ:ROKU) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on Roku is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.042 = US$142m ÷ (US$4.2b - US$855m) (Based on the trailing twelve months to March 2022).
Therefore, Roku has an ROCE of 4.2%. In absolute terms, that's a low return and it also under-performs the Entertainment industry average of 6.9%.
Above you can see how the current ROCE for Roku 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 Roku here for free.
So How Is Roku's ROCE Trending?
We're delighted to see that Roku is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 4.2% on its capital. In addition to that, Roku is employing 4,557% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 20%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Roku has grown its returns without a reliance on increasing their current liabilities, which we're very happy with.
The Key Takeaway
In summary, it's great to see that Roku has managed to break into profitability and is continuing to reinvest in its business. And since the stock has fallen 11% over the last three years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
Like most companies, Roku does come with some risks, and we've found 2 warning signs that you should be aware of.
While Roku may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
What are the risks and opportunities for Roku?
Trading at 57.4% below our estimate of its fair value
Revenue is forecast to grow 11.66% per year
Shareholders have been diluted in the past year
Currently unprofitable and not forecast to become profitable over the next 3 years
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.