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If you're looking for a multi-bagger, there's a few things to keep an eye out for. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. With that in mind, the ROCE of Costco Wholesale (NASDAQ:COST) looks attractive right now, so lets see what the trend of returns can tell us.
What is 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. To calculate this metric for Costco Wholesale, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$8.1b ÷ (US$64b - US$32b) (Based on the trailing twelve months to May 2022).
Therefore, Costco Wholesale has an ROCE of 25%. In absolute terms that's a great return and it's even better than the Consumer Retailing industry average of 9.1%.
Above you can see how the current ROCE for Costco Wholesale compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Costco Wholesale.
What Does the ROCE Trend For Costco Wholesale Tell Us?
Costco Wholesale deserves to be commended in regards to it's returns. The company has employed 124% more capital in the last five years, and the returns on that capital have remained stable at 25%. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
On a separate but related note, it's important to know that Costco Wholesale has a current liabilities to total assets ratio of 50%, which we'd consider pretty high. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Costco Wholesale's ROCE
In short, we'd argue Costco Wholesale has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And the stock has done incredibly well with a 179% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing to note, we've identified 2 warning signs with Costco Wholesale and understanding them should be part of your investment process.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.