If you’re looking for a multi-bagger, there’s a few things to keep an eye out for. Firstly, we’ll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. Speaking of which, we noticed some great changes in Netflix’s (NASDAQ:NFLX) returns on capital, so let’s have a look.
Understanding Return On Capital Employed (ROCE)
For those who don’t know, ROCE is a measure of a company’s yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Netflix is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.13 = US$4.1b ÷ (US$39b – US$7.9b) (Based on the trailing twelve months to September 2020).
Thus, Netflix has an ROCE of 13%. In absolute terms, that’s a pretty normal return, and it’s somewhat close to the Entertainment industry average of 15%.
In the above chart we have measured Netflix’s prior ROCE against its prior performance, but the future is arguably more important. If you’re interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
The trends we’ve noticed at Netflix are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 13%. The amount of capital employed has increased too, by 367%. So we’re very much inspired by what we’re seeing at Netflix thanks to its ability to profitably reinvest capital.
One more thing to note, Netflix has decreased current liabilities to 21% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
The Bottom Line On Netflix’s ROCE
All in all, it’s terrific to see that Netflix is reaping the rewards from prior investments and is growing its capital base. And a remarkable 333% total return over the last five years tells us that investors are expecting more good things to come in the future. So given the stock has proven it has promising trends, it’s worth researching the company further to see if these trends are likely to persist.
Netflix does have some risks though, and we’ve spotted 1 warning sign for Netflix that you might be interested in.
While Netflix may not currently earn the highest returns, we’ve compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
This article by Simply Wall St is general in nature. 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.