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What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at PayPal Holdings (NASDAQ:PYPL) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on PayPal Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.13 = US$4.3b ÷ (US$75b - US$42b) (Based on the trailing twelve months to September 2021).
Therefore, PayPal Holdings has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the IT industry average of 14%.
In the above chart we have measured PayPal Holdings' 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 PayPal Holdings.
How Are Returns Trending?
We like the trends that we're seeing from PayPal Holdings. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 13%. The amount of capital employed has increased too, by 109%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
Another thing to note, PayPal Holdings has a high ratio of current liabilities to total assets of 56%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
All in all, it's terrific to see that PayPal Holdings is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know about the risks facing PayPal Holdings, we've discovered 2 warning signs that you should be aware of.
While PayPal Holdings may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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