There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s 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, Rolls-Royce Holdings (LON:RR.) looks quite promising in regards to its trends of return on capital.
What Is 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. Analysts use this formula to calculate it for Rolls-Royce Holdings:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.087 = UK£1.3b ÷ (UK£30b – UK£15b) (Based on the trailing twelve months to June 2023).
Thus, Rolls-Royce Holdings has an ROCE of 8.7%. On its own, that’s a low figure but it’s around the 10% average generated by the Aerospace & Defense industry.
Check out our latest analysis for Rolls-Royce Holdings
In the above chart we have measured Rolls-Royce Holdings’ prior ROCE against its prior performance, but the future is arguably more important. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What The Trend Of ROCE Can Tell Us
We’re delighted to see that Rolls-Royce Holdings is reaping rewards from its investments and has now broken into profitability. While the business was unprofitable in the past, it’s now turned things around and is earning 8.7% on its capital. Interestingly, the capital employed by the business has remained relatively flat, so these higher returns are either from prior investments paying off or increased efficiencies. That being said, while an increase in efficiency is no doubt appealing, it’d be helpful to know if the company does have any investment plans going forward. Because in the end, a business can only get so efficient.
On a side note, Rolls-Royce Holdings’ current liabilities are still rather high at 50% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
In summary, we’re delighted to see that Rolls-Royce Holdings has been able to increase efficiencies and earn higher rates of return on the same amount of capital. Astute investors may have an opportunity here because the stock has declined 33% in the last five years. That being the case, research into the company’s current valuation metrics and future prospects seems fitting.
If you’d like to know more about Rolls-Royce Holdings, we’ve spotted 4 warning signs, and 2 of them shouldn’t be ignored.
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.
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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.