Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in First Advantage's (NASDAQ:FA) returns on capital, so let's have a look.
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. Analysts use this formula to calculate it for First Advantage:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.053 = US$81m ÷ (US$1.6b - US$95m) (Based on the trailing twelve months to September 2023).
Therefore, First Advantage has an ROCE of 5.3%. Ultimately, that's a low return and it under-performs the Professional Services industry average of 12%.
View our latest analysis for First Advantage
Above you can see how the current ROCE for First Advantage compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for First Advantage.
So How Is First Advantage's ROCE Trending?
First Advantage's ROCE growth is quite impressive. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 232% over the last three years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Bottom Line
To sum it up, First Advantage is collecting higher returns from the same amount of capital, and that's impressive. And with a respectable 33% awarded to those who held the stock over the last year, you could argue that these developments are starting to get the attention they deserve. Therefore, we think it would be worth your time to check if these trends are going to continue.
One more thing, we've spotted 1 warning sign facing First Advantage that you might find interesting.
While First Advantage isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.