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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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So when we looked at Shopify (NYSE:SHOP) and its trend of ROCE, we really liked what we saw.
Understanding 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. The formula for this calculation on Shopify is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0082 = US$92m ÷ (US$12b - US$682m) (Based on the trailing twelve months to March 2022).
Therefore, Shopify has an ROCE of 0.8%. In absolute terms, that's a low return and it also under-performs the IT industry average of 12%.
Above you can see how the current ROCE for Shopify 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 Shopify here for free.
What Can We Tell From Shopify's ROCE Trend?
The fact that Shopify is now generating some pre-tax profits from its prior investments is very encouraging. Shareholders would no doubt be pleased with this because the business was loss-making five years ago but is is now generating 0.8% on its capital. And unsurprisingly, like most companies trying to break into the black, Shopify is utilizing 2,489% 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.
What We Can Learn From Shopify's ROCE
Overall, Shopify gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. Since the stock has returned a staggering 253% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if Shopify can keep these trends up, it could have a bright future ahead.
Like most companies, Shopify does come with some risks, and we've found 3 warning signs that you should be aware of.
While Shopify 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. 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.