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First Advantage (NASDAQ:FA) Is Reinvesting At Lower Rates Of Return

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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at First Advantage (NASDAQ:FA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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. To calculate this metric for First Advantage, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.047 = US$84m ÷ (US$1.9b - US$100m) (Based on the trailing twelve months to March 2022).

So, First Advantage has an ROCE of 4.7%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 13%.

View our latest analysis for First Advantage

roce
roce

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'd like, you can check out the forecasts from the analysts covering First Advantage here for free.

So How Is First Advantage's ROCE Trending?

On the surface, the trend of ROCE at First Advantage doesn't inspire confidence. Over the last two years, returns on capital have decreased to 4.7% from 9.0% two years ago. 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.

The Bottom Line On First Advantage's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for First Advantage. And there could be an opportunity here if other metrics look good too, because the stock has declined 29% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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