There's Been No Shortage Of Growth Recently For British American Tobacco's (LON:BATS) Returns On Capital
To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing 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. With that in mind, we've noticed some promising trends at British American Tobacco (LON:BATS) so let's look a bit deeper.
Return On Capital Employed (ROCE): What Is It?
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. The formula for this calculation on British American Tobacco is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = UK£12b ÷ (UK£154b - UK£18b) (Based on the trailing twelve months to December 2022).
Thus, British American Tobacco has an ROCE of 8.6%. In absolute terms, that's a low return and it also under-performs the Tobacco industry average of 14%.
Check out our latest analysis for British American Tobacco
In the above chart we have measured British American Tobacco's 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.
How Are Returns Trending?
British American Tobacco has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 50% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
Our Take On British American Tobacco's ROCE
To bring it all together, British American Tobacco has done well to increase the returns it's generating from its capital employed. Considering the stock has delivered 5.9% to its stockholders over the last five years, it may be fair to think that investors aren't fully aware of the promising trends yet. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
One more thing to note, we've identified 2 warning signs with British American Tobacco and understanding them should be part of your investment process.
While British American Tobacco 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.
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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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