If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount 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 briefly looking over the numbers, we don't think Trade Desk (NASDAQ:TTD) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
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 Trade Desk:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = US$144m ÷ (US$2.8b - US$1.5b) (Based on the trailing twelve months to December 2020).
Thus, Trade Desk has an ROCE of 11%. By itself that's a normal return on capital and it's in line with the industry's average returns of 11%.
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'd like, you can check out the forecasts from the analysts covering Trade Desk here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at Trade Desk doesn't inspire confidence. To be more specific, ROCE has fallen from 41% over the last five years. 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 side note, Trade Desk's current liabilities are still rather high at 54% of total assets. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line On Trade Desk's ROCE
While returns have fallen for Trade Desk in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 775% return over the last three years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we've found 3 warning signs for Trade Desk that we think you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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What are the risks and opportunities for Trade Desk?
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