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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, we've noticed some promising trends at Western Digital (NASDAQ:WDC) so let's look a bit deeper.
What is 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 Western Digital is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.086 = US$1.9b ÷ (US$26b - US$4.7b) (Based on the trailing twelve months to October 2021).
Therefore, Western Digital has an ROCE of 8.6%. On its own that's a low return on capital but it's in line with the industry's average returns of 9.0%.
Above you can see how the current ROCE for Western Digital compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Western Digital here for free.
How Are Returns Trending?
Western Digital's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 141% whilst employing roughly the same amount of capital. So our take on this is that the business has increased efficiencies to generate these higher returns, all the while not needing to make any additional investments. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
Our Take On Western Digital's ROCE
In summary, we're delighted to see that Western Digital has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 4.3% to shareholders. So with that in mind, we think the stock deserves further research.
On a final note, we found 4 warning signs for Western Digital (1 is a bit concerning) you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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.
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