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. Speaking of which, we noticed some great changes in Netflix's (NASDAQ:NFLX) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What Is It?
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. Analysts use this formula to calculate it for Netflix:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$5.7b ÷ (US$48b - US$7.8b) (Based on the trailing twelve months to September 2022).
So, Netflix has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 8.7% generated by the Entertainment industry.
In the above chart we have measured Netflix's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Netflix.
So How Is Netflix's ROCE Trending?
Netflix is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 14%. The amount of capital employed has increased too, by 241%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 16%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business' underlying economics, which is great to see.
In summary, it's great to see that Netflix can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. Since the stock has returned a solid 53% to shareholders over the last five years, it's fair to say investors are beginning to recognize these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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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