If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. Ergo, when we looked at the ROCE trends at Microsoft (NASDAQ:MSFT), we liked what we saw.
What is Return On Capital Employed (ROCE)?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for Microsoft, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$53b ÷ (US$301b - US$72b) (Based on the trailing twelve months to June 2020).
So, Microsoft has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.
Above you can see how the current ROCE for Microsoft 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.
What Can We Tell From Microsoft's ROCE Trend?
It's hard not to be impressed by Microsoft's returns on capital. The company has consistently earned 23% for the last five years, and the capital employed within the business has risen 84% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.
The Key Takeaway
In short, we'd argue Microsoft 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 439% 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.
Like most companies, Microsoft does come with some risks, and we've found 2 warning signs that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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.
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