If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Ergo, when we looked at the ROCE trends at O'Reilly Automotive (NASDAQ:ORLY), we 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 O'Reilly Automotive:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.38 = US$2.4b ÷ (US$12b - US$5.3b) (Based on the trailing twelve months to December 2020).
Therefore, O'Reilly Automotive has an ROCE of 38%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 13%.
In the above chart we have measured O'Reilly Automotive'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?
It's hard not to be impressed by O'Reilly Automotive's returns on capital. Over the past five years, ROCE has remained relatively flat at around 38% and the business has deployed 74% more capital into its operations. Now considering ROCE is an attractive 38%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If O'Reilly Automotive can keep this up, we'd be very optimistic about its future.
Another thing to note, O'Reilly Automotive has a high ratio of current liabilities to total assets of 45%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
In summary, we're delighted to see that O'Reilly Automotive has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. Therefore it's no surprise that shareholders have earned a respectable 92% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you'd like to know about the risks facing O'Reilly Automotive, we've discovered 2 warning signs that you should be aware of.
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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