What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 Etsy (NASDAQ:ETSY) and its trend of ROCE, we really liked what we saw.
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. Analysts use this formula to calculate it for Etsy:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$502m ÷ (US$3.8b - US$616m) (Based on the trailing twelve months to December 2021).
Therefore, Etsy has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Online Retail industry average of 12% it's much better.
In the above chart we have measured Etsy's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
Etsy is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 16%. Basically the business is earning more per dollar of capital invested and in addition to that, 548% more capital is being employed now too. So we're very much inspired by what we're seeing at Etsy thanks to its ability to profitably reinvest capital.
The Bottom Line
A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Etsy has. Since the stock has returned a staggering 1,151% to shareholders over the last five years, it looks like investors are recognizing these changes. 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.
On a separate note, we've found 2 warning signs for Etsy you'll probably want to know about.
While Etsy 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.
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.