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. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. So, when we ran our eye over Frontier Developments' (LON:FDEV) trend of ROCE, we liked what we saw.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Frontier Developments is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.11 = UK£17m ÷ (UK£174m - UK£23m) (Based on the trailing twelve months to November 2022).
So, Frontier Developments has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.
In the above chart we have measured Frontier Developments' 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 trend of ROCE doesn't stand out much, but returns on a whole are decent. The company has employed 176% more capital in the last five years, and the returns on that capital have remained stable at 11%. 11% is a pretty standard return, and it provides some comfort knowing that Frontier Developments has consistently earned this amount. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.
The Bottom Line
The main thing to remember is that Frontier Developments has proven its ability to continually reinvest at respectable rates of return. However, despite the favorable fundamentals, the stock has fallen 57% over the last five years, so there might be an opportunity here for astute investors. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
On a final note, we found 3 warning signs for Frontier Developments (1 doesn't sit too well with us) you should be aware of.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.
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