What are the early trends we should look for to identify a stock that could multiply in value over the long term? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at Apple (NASDAQ:AAPL), it does have a high ROCE right now, but lets see how returns are trending.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Apple, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = US$74b ÷ (US$354b - US$133b) (Based on the trailing twelve months to December 2020).
Therefore, Apple has an ROCE of 34%. That's a fantastic return and not only that, it outpaces the average of 3.6% earned by companies in a similar industry.
Above you can see how the current ROCE for Apple compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Apple's ROCE Trending?
There hasn't been much to report for Apple's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 37% of total assets, this reported ROCE would probably be less than34% because total capital employed would be higher.The 34% ROCE could be even lower if current liabilities weren't 37% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn't high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
The Bottom Line
While Apple has impressive profitability from its capital, it isn't increasing that amount of capital. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 370% gain to shareholders who have held over the last five years. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Apple does have some risks though, and we've spotted 1 warning sign for Apple that you might be interested in.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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