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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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 Etsy's (NASDAQ:ETSY) returns on capital, so let's have a look.
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 Etsy, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = US$368m ÷ (US$2.4b - US$553m) (Based on the trailing twelve months to September 2024).
Therefore, Etsy has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Multiline Retail industry average of 12% it's much better.
View our latest analysis for Etsy
Above you can see how the current ROCE for Etsy compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Etsy .
The Trend Of ROCE
The trends we've noticed at Etsy are quite reassuring. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 19%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 41%. So we're very much inspired by what we're seeing at Etsy thanks to its ability to profitably reinvest capital.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Effectively this means that suppliers or short-term creditors are now funding 23% of the business, which is more than it was five years ago. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.
In Conclusion...
To sum it up, Etsy has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 12% to shareholders. So with that in mind, we think the stock deserves further research.