If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. And in light of that, the trends we're seeing at Facebook's (NASDAQ:FB) look very promising so lets take a look.
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 Facebook, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.22 = US$27b ÷ (US$138b - US$15b) (Based on the trailing twelve months to March 2020).
Therefore, Facebook has an ROCE of 22%. In absolute terms that's a great return and it's even better than the Interactive Media and Services industry average of 6.7%.
In the above chart we have a measured Facebook'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 Facebook.
The Trend Of ROCE
The trends we've noticed at Facebook are quite reassuring. The data shows that returns on capital have increased substantially over the last five years to 22%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 206%. 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.
The Key Takeaway
To sum it up, Facebook has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 142% to shareholders over the last five years, it looks like investors are recognizing these changes. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing to note, we've identified 1 warning sign with Facebook and understanding this should be part of your investment process.
Facebook 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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