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Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, the ROCE of CDK Global (NASDAQ:CDK) looks great, so lets see what the trend can tell us.
Return On Capital Employed (ROCE): What is it?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for CDK Global:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$604m ÷ (US$3.0b - US$555m) (Based on the trailing twelve months to March 2020).
Therefore, CDK Global has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 9.3% earned by companies in a similar industry.
Above you can see how the current ROCE for CDK Global 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.
What The Trend Of ROCE Can Tell Us
CDK Global has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 31% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
As discussed above, CDK Global appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Astute investors may have an opportunity here because the stock has declined 20% in the last five years. With that in mind, we believe the promising trends warrant this stock for further investigation.
CDK Global does have some risks, we noticed 3 warning signs (and 1 which is a bit unpleasant) we think you should know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
This article by Simply Wall St is general in nature. 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.
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