If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Trade Desk (NASDAQ:TTD), we don't think it's current trends fit the mold of a multi-bagger.
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. To calculate this metric for Trade Desk, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = US$100m ÷ (US$3.4b - US$1.5b) (Based on the trailing twelve months to March 2022).
Therefore, Trade Desk has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the Software industry average of 9.7%.
In the above chart we have measured Trade Desk'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.
The Trend Of ROCE
On the surface, the trend of ROCE at Trade Desk doesn't inspire confidence. Over the last five years, returns on capital have decreased to 5.3% from 28% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a related note, Trade Desk has decreased its current liabilities to 45% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.
The Bottom Line
In summary, despite lower returns in the short term, we're encouraged to see that Trade Desk is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 785% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, Trade Desk does come with some risks, and we've found 3 warning signs that you should be aware of.
While Trade Desk 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.
What are the risks and opportunities for Trade Desk?
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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.