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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? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at carsales.com (ASX:CAR) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Understanding 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 carsales.com is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = AU$166m ÷ (AU$999m - AU$72m) (Based on the trailing twelve months to June 2020).
Thus, carsales.com has an ROCE of 18%. In absolute terms, that's a satisfactory return, but compared to the Interactive Media and Services industry average of 12% it's much better.
View our latest analysis for carsales.com
Above you can see how the current ROCE for carsales.com compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From carsales.com's ROCE Trend?
On the surface, the trend of ROCE at carsales.com doesn't inspire confidence. Over the last five years, returns on capital have decreased to 18% from 34% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
The Bottom Line On carsales.com's ROCE
In summary, carsales.com is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Investors must think there's better things to come because the stock has knocked it out of the park delivering a 145% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.