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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. So, when we ran our eye over Align Technology's (NASDAQ:ALGN) trend of ROCE, we really liked what we saw.
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. The formula for this calculation on Align Technology is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = US$885m ÷ (US$5.4b - US$1.7b) (Based on the trailing twelve months to June 2021).
Therefore, Align Technology has an ROCE of 24%. In absolute terms that's a great return and it's even better than the Medical Equipment industry average of 8.7%.
Above you can see how the current ROCE for Align Technology 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 Align Technology.
What Does the ROCE Trend For Align Technology Tell Us?
We'd be pretty happy with returns on capital like Align Technology. The company has employed 288% more capital in the last five years, and the returns on that capital have remained stable at 24%. Returns like this are the envy of most businesses and given it has repeatedly reinvested at these rates, that's even better. If Align Technology can keep this up, we'd be very optimistic about its future.
What We Can Learn From Align Technology's ROCE
In summary, we're delighted to see that Align Technology has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 633% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
One more thing, we've spotted 2 warning signs facing Align Technology that you might find interesting.
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. 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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