If you’re not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Having said that, from a first glance at Trade Desk (NASDAQ:TTD) we aren’t jumping out of our chairs at how returns are trending, but let’s have a deeper look.
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 Trade Desk, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.07 = US$125m ÷ (US$3.6b – US$1.8b) (Based on the trailing twelve months to December 2021).
Thus, Trade Desk has an ROCE of 7.0%. Ultimately, that’s a low return and it under-performs the Software industry average of 9.2%.
In the above chart we have measured Trade Desk’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 Trade Desk.
So How Is Trade Desk’s ROCE Trending?
In terms of Trade Desk’s historical ROCE movements, the trend isn’t fantastic. Around five years ago the returns on capital were 30%, but since then they’ve fallen to 7.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.
On a side note, Trade Desk has done well to pay down its current liabilities to 50% of total assets. So we could link some of this to the decrease in ROCE. What’s more, this can reduce some aspects of risk to the business because now the company’s suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business’ efficiency at generating ROCE since it is now funding more of the operations with its own money. Either way, they’re still at a pretty high level, so we’d like to see them fall further if possible.
What We Can Learn From Trade Desk’s ROCE
While returns have fallen for Trade Desk in recent times, we’re encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 738% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
Trade Desk does have some risks though, and we’ve spotted 3 warning signs for Trade Desk that you might be interested in.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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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.