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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So while Frontdoor (NASDAQ:FTDR) has a high ROCE right now, lets see what we can decipher from how returns are changing.
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. Analysts use this formula to calculate it for Frontdoor:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.35 = US$228m ÷ (US$1.1b - US$402m) (Based on the trailing twelve months to March 2022).
Thus, Frontdoor has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Consumer Services industry average of 6.3%.
Check out our latest analysis for Frontdoor
In the above chart we have measured Frontdoor'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 Frontdoor.
What The Trend Of ROCE Can Tell Us
Things have been pretty stable at Frontdoor, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. Although current returns are high, we'd need more evidence of underlying growth for it to look like a multi-bagger going forward.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 38% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.
What We Can Learn From Frontdoor's ROCE
In summary, Frontdoor isn't compounding its earnings but is generating decent returns on the same amount of capital employed. Since the stock has declined 40% over the last three years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Frontdoor has the makings of a multi-bagger.