If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of AO World (LON:AO.) looks great, so lets see what the trend can tell us.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for AO World, this is the formula:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = UK£37m ÷ (UK£440m - UK£255m) (Based on the trailing twelve months to September 2023).

Therefore, AO World has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 14%.

View our latest analysis for AO World  roce

Above you can see how the current ROCE for AO World 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 AO World here  for free.

What The Trend Of ROCE Can Tell Us

AO World has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 20% on its capital. And unsurprisingly, like most companies trying to break into the black, AO World is utilizing 123% more capital than it was five years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

On a side note, AO World's current liabilities are still rather high at 58% of total assets. 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.



In Conclusion...

To the delight of most shareholders, AO World has now broken into profitability. Given the stock has declined 28% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. That being the case, research into the company's current valuation metrics and future prospects seems fitting.

While AO World looks impressive, no company is worth an infinite price. The  intrinsic value infographic in our free research report  helps visualize whether AO. is currently trading for a fair price.

If you want to search for more stocks that have been earning high returns, check out this freelist of stocks with solid balance sheets that are also earning high 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.