Here's What REA Group's (ASX:REA) Strong Returns On Capital Mean

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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 REA Group (ASX:REA) looks attractive right now, so lets see what the trend of returns can tell us.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for REA Group, this is the formula:

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

0.25 = AU$549m ÷ (AU$2.5b - AU$278m) (Based on the trailing twelve months to December 2022).

Therefore, REA Group has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 8.8% earned by companies in a similar industry.

View our latest analysis for REA Group

roce

In the above chart we have measured REA Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering REA Group here for free.

The Trend Of ROCE

It's hard not to be impressed by REA Group's returns on capital. The company has consistently earned 25% for the last five years, and the capital employed within the business has risen 75% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. You'll see this when looking at well operated businesses or favorable business models.

One more thing to note, even though ROCE has remained relatively flat over the last five years, the reduction in current liabilities to 11% of total assets, is good to see from a business owner's perspective. Effectively suppliers now fund less of the business, which can lower some elements of risk.

The Bottom Line

REA Group has demonstrated its proficiency by generating high returns on increasing amounts of capital employed, which we're thrilled about. Therefore it's no surprise that shareholders have earned a respectable 76% return if they held 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.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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