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To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Wesfarmers (ASX:WES) looks attractive right now, so lets see what the trend of returns can tell us.
Understanding 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 Wesfarmers, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = AU$3.8b ÷ (AU$27b - AU$8.5b) (Based on the trailing twelve months to December 2023).
So, Wesfarmers has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 9.6%.
Check out our latest analysis for Wesfarmers
Above you can see how the current ROCE for Wesfarmers 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 analyst report for Wesfarmers .
How Are Returns Trending?
Wesfarmers deserves to be commended in regards to it's returns. Over the past five years, ROCE has remained relatively flat at around 20% and the business has deployed 28% more capital into its operations. Now considering ROCE is an attractive 20%, this combination is actually pretty appealing because it means the business can consistently put money to work and generate these high returns. If Wesfarmers can keep this up, we'd be very optimistic about its future.
The Key Takeaway
In summary, we're delighted to see that Wesfarmers has been compounding returns by reinvesting at consistently high rates of return, as these are common traits of a multi-bagger. And long term investors would be thrilled with the 134% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
If you want to continue researching Wesfarmers, you might be interested to know about the 2 warning signs that our analysis has discovered.
High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.
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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.