To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. With that in mind, the ROCE of PayPal Holdings (NASDAQ:PYPL) looks decent, right now, so lets see what the trend of returns can tell us.
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. The formula for this calculation on PayPal Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.11 = US$3.7b ÷ (US$78b – US$45b) (Based on the trailing twelve months to June 2022).
Therefore, PayPal Holdings has an ROCE of 11%. That’s a relatively normal return on capital, and it’s around the 12% generated by the IT industry.
In the above chart we have measured PayPal Holdings’ 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 PayPal Holdings.
How Are Returns Trending?
While the returns on capital are good, they haven’t moved much. Over the past five years, ROCE has remained relatively flat at around 11% and the business has deployed 96% more capital into its operations. Since 11% is a moderate ROCE though, it’s good to see a business can continue to reinvest at these decent rates of return. 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.
Another thing to note, PayPal Holdings has a high ratio of current liabilities to total assets of 58%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On PayPal Holdings’ ROCE
To sum it up, PayPal Holdings has simply been reinvesting capital steadily, at those decent rates of return. In light of this, the stock has only gained 18% over the last five years for shareholders who have owned the stock in this period. That’s why it could be worth your time looking into this stock further to discover if it has more traits of a multi-bagger.
On a separate note, we’ve found 3 warning signs for PayPal Holdings you’ll probably want to know about.
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.
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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.
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