Australia markets open in 5 minutes
  • ALL ORDS

    7,713.10
    -32.80 (-0.42%)
     
  • AUD/USD

    0.6962
    +0.0071 (+1.03%)
     
  • ASX 200

    7,504.10
    -34.90 (-0.46%)
     
  • OIL

    77.59
    +0.45 (+0.58%)
     
  • GOLD

    1,885.10
    +5.60 (+0.30%)
     
  • BTC-AUD

    33,431.24
    +294.71 (+0.89%)
     
  • CMC Crypto 200

    534.56
    +8.61 (+1.64%)
     

Here's What REA Group's (ASX:REA) Strong Returns On Capital Mean

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. So, when we ran our eye over REA Group's (ASX:REA) trend of ROCE, we really liked what we saw.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on REA Group is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.25 = AU$555m ÷ (AU$2.6b - AU$350m) (Based on the trailing twelve months to June 2022).

Thus, REA Group has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 13% earned by companies in a similar industry.

Check out our latest analysis for REA Group

roce
roce

In the above chart we have measured REA Group'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 REA Group here for free.

So How Is REA Group's ROCE Trending?

It's hard not to be impressed by REA Group's returns on capital. Over the past five years, ROCE has remained relatively flat at around 25% and the business has deployed 85% more capital into its operations. Now considering ROCE is an attractive 25%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If REA Group can keep this up, we'd be very optimistic about its future.

On a side note, REA Group has done well to reduce current liabilities to 14% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Key Takeaway

In the end, the company has proven it can reinvest it's capital at high rates of returns, which you'll remember is a trait of a multi-bagger. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

REA Group does have some risks though, and we've spotted 1 warning sign for REA Group that you might be interested in.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.

Join A Paid User Research Session
You’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here