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Here's What To Make Of Estée Lauder Companies' (NYSE:EL) Returns On Capital

Simply Wall St

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What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. 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 Estée Lauder Companies (NYSE:EL), it does have a high ROCE right now, but lets see how returns are trending.

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 Estée Lauder Companies:

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

0.20 = US$2.6b ÷ (US$18b - US$5.7b) (Based on the trailing twelve months to March 2020).

Thus, Estée Lauder Companies has an ROCE of 20%. In absolute terms that's a very respectable return and compared to the Personal Products industry average of 21% it's pretty much on par.

View our latest analysis for Estée Lauder Companies

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In the above chart we have a measured Estée Lauder Companies' prior ROCE against its prior performance, but the future is arguably more important. 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

When we looked at the ROCE trend at Estée Lauder Companies, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 29%. 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 may take some time before the company starts to see any change in earnings from these investments.

The Bottom Line

Bringing it all together, while we're somewhat encouraged by Estée Lauder Companies' reinvestment in its own business, we're aware that returns are shrinking. Investors must think there's better things to come because the stock has knocked it out of the park delivering a 137% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Estée Lauder Companies does have some risks though, and we've spotted 4 warning signs for Estée Lauder Companies that you might be interested in.

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.

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.

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