If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Purple Innovation (NASDAQ:PRPL) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
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. To calculate this metric for Purple Innovation, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = US$46m ÷ (US$579m - US$120m) (Based on the trailing twelve months to June 2021).
So, Purple Innovation has an ROCE of 10%. In isolation, that's a pretty standard return but against the Consumer Durables industry average of 15%, it's not as good.
Above you can see how the current ROCE for Purple Innovation 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 Purple Innovation.
What The Trend Of ROCE Can Tell Us
We're delighted to see that Purple Innovation is reaping rewards from its investments and is now generating some pre-tax profits. The company was generating losses three years ago, but now it's earning 10% which is a sight for sore eyes. And unsurprisingly, like most companies trying to break into the black, Purple Innovation is utilizing 1,294% more capital than it was three years ago. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.
On a related note, the company's ratio of current liabilities to total assets has decreased to 21%, which basically reduces it's funding from the likes of short-term creditors or suppliers. So shareholders would be pleased that the growth in returns has mostly come from underlying business performance.
To the delight of most shareholders, Purple Innovation has now broken into profitability. Since the stock has returned a staggering 303% to shareholders over the last three 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 Purple Innovation can keep these trends up, it could have a bright future ahead.
If you want to continue researching Purple Innovation, you might be interested to know about the 2 warning signs that our analysis has discovered.
While Purple Innovation isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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