If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Ergo, when we looked at the ROCE trends at Costco Wholesale (NASDAQ:COST), we liked what we saw.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Costco Wholesale is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.25 = US$7.6b ÷ (US$64b - US$33b) (Based on the trailing twelve months to November 2021).
Thus, Costco Wholesale has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 8.0% earned by companies in a similar industry.
In the above chart we have measured Costco Wholesale's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Costco Wholesale here for free.
So How Is Costco Wholesale's ROCE Trending?
We'd be pretty happy with returns on capital like Costco Wholesale. The company has consistently earned 25% for the last five years, and the capital employed within the business has risen 77% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.
On a side note, Costco Wholesale's current liabilities are still rather high at 52% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
What We Can Learn From Costco Wholesale's ROCE
In summary, we're delighted to see that Costco Wholesale has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 236% return they've received over the last five years. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.
Like most companies, Costco Wholesale does come with some risks, and we've found 1 warning sign that you should be aware of.
If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets here.
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