First Advantage (NASDAQ:FA) May Have Issues Allocating Its Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. In light of that, when we looked at First Advantage (NASDAQ:FA) and its ROCE trend, we weren't exactly thrilled.
Understanding 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. The formula for this calculation on First Advantage is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.051 = US$90m ÷ (US$1.8b - US$85m) (Based on the trailing twelve months to March 2023).
So, First Advantage has an ROCE of 5.1%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 12%.
See our latest analysis for First Advantage
Above you can see how the current ROCE for First Advantage 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.
The Trend Of ROCE
In terms of First Advantage's historical ROCE movements, the trend isn't fantastic. Over the last three years, returns on capital have decreased to 5.1% from 9.0% three years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On First Advantage's ROCE
Bringing it all together, while we're somewhat encouraged by First Advantage's reinvestment in its own business, we're aware that returns are shrinking. Since the stock has gained an impressive 12% over the last year, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
First Advantage could be trading at an attractive price in other respects, so you might find our free intrinsic value estimation on our platform quite valuable.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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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.
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