AO World (LON: AO.) Capital returns are on the rise
What trends should we look for if we are to identify stocks that can multiply in value over the long term? Ideally, a business will display two trends; first growth to recover on capital employed (ROCE) and on the other hand, an increase amount capital employed. Put simply, these types of businesses are dialing machines, which means they continually reinvest their profits at ever higher rates of return. So when we looked AO World (LON: AO.) And its trend of ROCE, we really liked what we saw.
What is Return on Employee Capital (ROCE)?
For those who don’t know what ROCE is, it measures the amount of pre-tax profit a business can generate from the capital employed in its business. Analysts use this formula to calculate it for AO World:
Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.17 = £ 32million (£ 616million – £ 433million) (Based on the last twelve months up to March 2021).
Therefore, AO World has a ROCE of 17%. By itself, this is a normal return on capital and is in line with industry average returns of 17%.
See our latest analysis for AO World
Above you can see how AO World’s current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you like, you can view analyst forecasts covering AO World here for free.
So what’s the AO World ROCE trend?
The fact that AO World is now generating pre-tax profits on its past investments is very encouraging. The company was making losses five years ago, but now it’s gaining 17%, which is a sight to behold. Not only that, but the business is using 222% more capital than before, but that’s to be expected of a business trying to become profitable. We like this trend because it tells us that the company has profitable reinvestment opportunities, and if it keeps moving forward it can lead to multi-bagger performance.
On a separate but related note, it’s important to know that AO World has a 70% current liabilities to total assets ratio, which we consider to be quite high. What this actually means is that suppliers (or short-term creditors) fund a large portion of the business, so just be aware that this can introduce some elements of risk. While this isn’t necessarily a bad thing, it can be beneficial if this ratio is lower.
What we can learn from AO World’s ROCE
To the delight of most shareholders, AO World has now returned to profitability. Since the stock has only returned 30% to shareholders over the past five years, promising fundamentals may not yet be recognized by investors. So with that in mind, we believe the stock deserves further research.
While AO World looks impressive, no business is worth an endless price. The intrinsic value infographic in our free search report allows you to view whether AO. is currently trading at a fair price.
For those who like to invest in solid companies, Check it out free list of companies with strong balance sheets and high returns on equity.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.
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