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If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Ergo, when we looked at the ROCE trends at Wesfarmers (ASX:WES), we liked what we saw.
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. Analysts use this formula to calculate it for Wesfarmers:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = AU$3.8b ÷ (AU$27b - AU$8.2b) (Based on the trailing twelve months to June 2024).
Thus, Wesfarmers has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 9.3%.
Check out our latest analysis for Wesfarmers
In the above chart we have measured Wesfarmers' 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 analyst report for Wesfarmers .
What Can We Tell From Wesfarmers' ROCE Trend?
Wesfarmers deserves to be commended in regards to it's returns. The company has consistently earned 20% for the last five years, and the capital employed within the business has risen 45% in that time. Now considering ROCE is an attractive 20%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If these trends can continue, it wouldn't surprise us if the company became a multi-bagger.
What We Can Learn From Wesfarmers' ROCE
In summary, we're delighted to see that Wesfarmers has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. On top of that, the stock has rewarded shareholders with a remarkable 103% return to those who've held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
If you'd like to know about the risks facing Wesfarmers, we've discovered 3 warning signs that you should be aware of.