What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we’d want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. If you see this, it typically means it’s a company with a great business model and plenty of profitable reinvestment opportunities. That’s why when we briefly looked at Ferrari’s (NYSE:RACE) ROCE trend, we were pretty happy with what we saw.
Return On Capital Employed (ROCE): What is it?
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 Ferrari is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.14 = €716m ÷ (€6.0b – €927m) (Based on the trailing twelve months to December 2020).
Thus, Ferrari has an ROCE of 14%. On its own, that’s a standard return, however it’s much better than the 11% generated by the Auto industry.
In the above chart we have measured Ferrari’s 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 Ferrari.
So How Is Ferrari’s ROCE Trending?
The trend of ROCE doesn’t stand out much, but returns on a whole are decent. The company has employed 45% more capital in the last five years, and the returns on that capital have remained stable at 14%. 14% is a pretty standard return, and it provides some comfort knowing that Ferrari has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 15% of total assets, is good to see from a business owner’s perspective. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.
The Bottom Line
In the end, Ferrari has proven its ability to adequately reinvest capital at good rates of return. And long term investors would be thrilled with the 437% return they’ve received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
One more thing, we’ve spotted 1 warning sign facing Ferrari that you might find interesting.
While Ferrari 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.
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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.
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