This analysis is intended to introduce important early concepts to people who are starting to invest and want to better understand how you can grow your money by investing in Facebook Inc (NASDAQ:FB).
Purchasing Facebook gives you an ownership stake in the company. This share represents a portion of capital used by the company to operate the business, and it is important the company is able to use the capital base efficiently to create adequate cash flows for you as an investor. You need to pay attention to this because your return on investment is linked to dividends and internal investments to improve the business, which can only occur if the company is expected to produce adequate earnings with the capital that has been provided. Thus, to understand how your money can grow by investing in Facebook, you need to look at what the company returns to owners for the use of their capital, which can be done in many ways but today we will use return on capital employed (ROCE).
Facebook’s Return On Capital Employed
When you choose to invest in a company, there is an opportunity cost because that money could’ve been invested elsewhere. Therefore all else aside, your investment in a certain company represents a vote of confidence that the money used to buy the stock will grow larger than if invested elsewhere. So the business’ ability to grow the size of your capital is very important and can be assessed by comparing the return on capital you can get on your investment with a hurdle rate that depends on the other return possibilities you can identify. To determine Facebook’s capital return we will use ROCE, which tells us how much the company makes from the capital employed in their operations (for things like machinery, wages etc). FB’s ROCE is calculated below:
ROCE Calculation for FB
Return on Capital Employed (ROCE) = Earnings Before Tax (EBT) ÷ (Capital Employed)
Capital Employed = (Total Assets – Current Liabilities)
∴ ROCE = US$22.80b ÷ (US$88.95b – US$5.09b) = 27.18%
As you can see, FB earned $27.2 from every $100 you invested over the previous twelve months. This shows Facebook provides a great return on capital employed that is well above the 15% ROCE that is typically considered to be a strong benchmark. As a result, if FB is clever with their reinvestments or dividend payments, investors can grow their capital at an enviable rate over time.
Does this mean I should invest?
Facebook’s relatively strong ROCE is tied to the movement in two factors that change over time: earnings and capital requirements. At the moment Facebook is in a favourable position, but this can change if these factors underperform. Because of this, it is important to look beyond the final value of FB’s ROCE and understand what is happening to the individual components. Looking three years in the past, it is evident that FB’s ROCE has risen from 11.75%, indicating the company’s capital returns have stengthened. We can see that earnings have increased from US$4.73b to US$22.80b whilst capital employed also increased but to a smaller extent, which means the company has been able to improve ROCE by driving up earnings relative to the capital invested in the business.
ROCE for FB investors has grown in the last few years and is above a benchmark that makes the company a potentially attractive stock that can achieve a solid return on investment. As an investor this is the type of situation you look for, but return on capital employed is a static metric that should be looked at in conjunction with other fundamental indicators like future prospects and valuation. Without considering these fundamentals, you cannot be sure if this trend will continue or if you are getting a good deal for the future returns you are paying for. If you’re interested in diving deeper, take a look at what I’ve linked below for further information on these fundamentals and other potential investment opportunities.
- Future Outlook: What are well-informed industry analysts predicting for FB’s future growth? Take a look at our free research report of analyst consensus for FB’s outlook.
- Valuation: What is FB worth today? Is the stock undervalued, even if its ROCE is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether FB is currently mispriced by the market.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.