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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at AO World (LON:AO.) so let's look a bit deeper.

Return On Capital Employed (ROCE): What Is It?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on AO World is:

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

0.069 = UK£13m ÷ (UK£460m - UK£279m) (Based on the trailing twelve months to March 2023).

Thus, AO World has an ROCE of 6.9%.  In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.

See our latest analysis for AO World  roce

In the above chart we have measured AO World'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 freereport for AO World.

What Does the ROCE Trend For AO World Tell Us?

We're delighted to see that AO World is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses five years ago, but now it's earning 6.9% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, AO World is utilizing 91% more capital than it was five years ago. We like this trend, because it tells us the company has profitable reinvestment opportunities available to it, and if it continues going forward that can lead to a multi-bagger performance.

On a separate but related note, it's important to know that AO World has a current liabilities to total assets ratio of 61%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From AO World's ROCE

Overall, AO World gets a big tick from us thanks in most part to the fact that it is now profitable and is reinvesting in its business. And since the stock has fallen 45% over the last five years, there might be an opportunity here. So researching this company further and determining whether or not these trends will continue seems justified.

On a separate note, we've found  1 warning sign for AO World  you'll probably want to know about.

For those who like to invest in solid companies, check out this freelist of companies with solid balance sheets and high returns on equity.

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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