Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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. Although, when we looked at Alibaba Group Holding (NYSE:BABA), it didn't seem to tick all of these boxes.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Alibaba Group Holding:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.072 = CN¥95b ÷ (CN¥1.7t - CN¥384b) (Based on the trailing twelve months to March 2022).
So, Alibaba Group Holding has an ROCE of 7.2%. Ultimately, that's a low return and it under-performs the Online Retail industry average of 12%.
Above you can see how the current ROCE for Alibaba Group Holding compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Alibaba Group Holding here for free.
What Can We Tell From Alibaba Group Holding's ROCE Trend?
When we looked at the ROCE trend at Alibaba Group Holding, we didn't gain much confidence. To be more specific, ROCE has fallen from 12% over the last five years. 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. If these investments prove successful, this can bode very well for long term stock performance.
Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Alibaba Group Holding. These growth trends haven't led to growth returns though, since the stock has fallen 17% over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
Like most companies, Alibaba Group Holding does come with some risks, and we've found 3 warning signs that you should be aware of.
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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.