If we’re going to find a title that could multiply over the long term, what are the underlying trends to look for? Among other things, we’ll want to see two things; first, a growth return on capital employed (ROCE) and on the other hand, an expansion of the company amount capital employed. This shows us that it is a compounding machine, capable of continually reinvesting its profits into the business and generating higher returns. Ergo, when we looked at the trends in ROCE at Costco Wholesale (NASDAQ: COST), we liked what we saw.
What is Return on Capital Employed (ROCE)?
Just to clarify if you’re not sure, ROCE is a measure of the pre-tax income (as a percentage) that a business earns on the capital invested in its business. To calculate this metric for Costco Wholesale, here is the formula:
Return on capital employed = Earnings before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)
0.24 = $ 7.0 billion ÷ ($ 57 billion – $ 28 billion) (Based on the last twelve months up to May 2021).
Therefore, Costco Wholesale has 24% ROCE. This is a fantastic return and not only that, it exceeds the 9.5% average earned by companies in a similar industry.
Check out our latest analysis for Costco Wholesale
In the chart above, we’ve measured Costco Wholesale’s past ROCE versus past performance, but arguably the future is more important. If you’d like to see what analysts are forecasting for the future, you should check out our free report for Costco Wholesale.
What the ROCE trend can tell us
As for Costco Wholesale’s ROCE story, it’s pretty impressive. The company has employed 73% more capital over the past five years, and returns on that capital have remained stable at 24%. Now that the ROCE is attractive at 24%, this combination is actually quite attractive because it means that the company can constantly put money to work and generate those high returns. If Costco Wholesale can continue this momentum, we would be very optimistic about its future.
On a separate but related note, it’s important to know that Costco Wholesale has a current liabilities to total assets ratio of 49%, which we consider to be quite high. What this actually means is that suppliers (or short-term creditors) fund a large portion of the business, so just be aware that this can introduce some elements of risk. While this isn’t necessarily a bad thing, it can be beneficial if this ratio is lower.
Our take on Costco Wholesale’s ROCE
In short, we would say that Costco Wholesale has the makings of a multi-bagger since it has been able to compose its capital at very profitable rates of return. And long-term investors would be delighted with the 180% return they’ve achieved over the past five years. So while the positive underlying trends can be explained by investors, we still believe this action is worth looking into.
One more thing, we spotted 2 warning signs facing Costco Wholesale that you might find interesting.
If you’d like to see other companies driving high returns, check out our free List of high yielding companies with strong balance sheets here.
If you are looking to negotiate Costco Wholesale, open an account with the cheapest * professionally approved platform, Interactive Brokers. Their clients from more than 200 countries and territories trade stocks, options, futures, currencies, bonds and funds around the world from a single integrated account.
This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take into account your goals or your financial situation. We aim to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative information. Simply Wall St has no position in any of the stocks mentioned.
*Interactive Brokers Ranked Least Expensive Broker By StockBrokers.com Annual Online Review 2020
Do you have any comments on this article? Concerned about the content? Get in touch with us directly. You can also email the editorial team (at) simplywallst.com.