There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Wayfair (NYSE:W) and its trend of ROCE, 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 Wayfair:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = US$364m ÷ (US$4.6b - US$2.2b) (Based on the trailing twelve months to December 2020).
Thus, Wayfair has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Online Retail industry average of 14%.
In the above chart we have measured Wayfair's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Wayfair.
So How Is Wayfair's ROCE Trending?
We're delighted to see that Wayfair is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 15% which is a sight for sore eyes. Not only that, but the company is utilizing 709% more capital than before, but that's to be expected from a company trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a separate but related note, it's important to know that Wayfair has a current liabilities to total assets ratio of 47%, which we'd consider pretty high. 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.
Overall, Wayfair gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a staggering 659% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
Wayfair does come with some risks though, we found 4 warning signs in our investment analysis, and 2 of those are concerning...
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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