If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, First Advantage (NASDAQ:FA) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for First Advantage, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = US$81m ÷ (US$1.6b - US$95m) (Based on the trailing twelve months to September 2023).
So, First Advantage has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 12%.
In the above chart we have measured First Advantage's 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 report for First Advantage.
How Are Returns Trending?
First Advantage has not disappointed with their ROCE growth. The figures show that over the last three years, ROCE has grown 232% 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. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.
The Key Takeaway
As discussed above, First Advantage appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. And with a respectable 30% awarded to those who held the stock over the last year, you could argue that these developments are starting to get the attention they deserve. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you want to continue researching First Advantage, you might be interested to know about the 1 warning sign that our analysis has discovered.
While First Advantage may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.