Is O'Reilly Automotive (NASDAQ:ORLY) A Compounding Machine?

What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of O'Reilly Automotive (NASDAQ:ORLY) looks attractive right now, so lets see what the trend of returns can tell us.

Understanding Return On Capital Employed (ROCE)

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. The formula for this calculation on O'Reilly Automotive is:

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

0.34 = US$2.3b ÷ (US$13b - US$5.7b) (Based on the trailing twelve months to September 2020).

Therefore, O'Reilly Automotive has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 13%.

Check out our latest analysis for O'Reilly Automotive

Above you can see how the current ROCE for O'Reilly Automotive compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

In terms of O'Reilly Automotive's history of ROCE, it's quite impressive. The company has consistently earned 34% for the last five years, and the capital employed within the business has risen 86% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If O'Reilly Automotive can keep this up, we'd be very optimistic about its future.

On a side note, O'Reilly Automotive's current liabilities are still rather high at 45% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From O'Reilly Automotive's ROCE

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And the stock has done incredibly well with a 106% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

On a separate note, we've found 2 warning signs for O'Reilly Automotive you'll probably want to know about.

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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