If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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 while Tractor Supply (NASDAQ:TSCO) has a high ROCE right now, lets see what we can decipher from how returns are changing.
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. Analysts use this formula to calculate it for Tractor Supply:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.24 = US$1.3b ÷ (US$7.4b - US$2.0b) (Based on the trailing twelve months to March 2021).
So, Tractor Supply has an ROCE of 24%. That's a fantastic return and not only that, it outpaces the average of 15% earned by companies in a similar industry.
In the above chart we have measured Tractor Supply'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 Tractor Supply.
The Trend Of ROCE
When we looked at the ROCE trend at Tractor Supply, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 38%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Tractor Supply. And the stock has done incredibly well with a 100% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
If you'd like to know about the risks facing Tractor Supply, we've discovered 2 warning signs that you should be aware of.
Tractor Supply is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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