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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? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Looking at Tractor Supply (NASDAQ:TSCO), it does have a high ROCE right now, but lets see how returns are trending.
Return On Capital Employed (ROCE): What is it?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Tractor Supply, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$1.1b ÷ (US$6.9b - US$2.1b) (Based on the trailing twelve months to September 2020).
Thus, Tractor Supply has an ROCE of 23%. That's a fantastic return and not only that, it outpaces the average of 13% 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
When we looked at the ROCE trend at Tractor Supply, we didn't gain much confidence. To be more specific, while the ROCE is still high, it's fallen from 39% where it was five years ago. 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. If these investments prove successful, this can bode very well for long term stock performance.
What We Can Learn From Tractor Supply's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that Tractor Supply is reinvesting for growth and has higher sales as a result. And the stock has followed suit returning a meaningful 74% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.
Like most companies, Tractor Supply does come with some risks, and we've found 1 warning sign that you should be aware of.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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