What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Speaking of which, we noticed some great changes in Netflix‘s (NASDAQ:NFLX) returns on capital, so let’s have a look.
What is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Netflix, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.17 = US$5.6b ÷ (US$40b – US$8.0b) (Based on the trailing twelve months to March 2021).
Thus, Netflix has an ROCE of 17%. In absolute terms, that’s a satisfactory return, but compared to the Entertainment industry average of 12% it’s much better.
Check out our latest analysis for Netflix
Above you can see how the current ROCE for Netflix compares to its prior returns on capital, but there’s only so much you can tell from the past. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Netflix Tell Us?
Investors would be pleased with what’s happening at Netflix. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 17%. The amount of capital employed has increased too, by 339%. So we’re very much inspired by what we’re seeing at Netflix thanks to its ability to profitably reinvest capital.
On a related note, the company’s ratio of current liabilities to total assets has decreased to 20%, which basically reduces it’s funding from the likes of short-term creditors or suppliers. So this improvement in ROCE has come from the business’ underlying economics, which is great to see.
The Bottom Line
In summary, it’s great to see that Netflix can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it’s worth looking further into this stock because if Netflix can keep these trends up, it could have a bright future ahead.
On a separate note, we’ve found 1 warning sign for Netflix you’ll probably want to know about.
While Netflix 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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