There are a few key trends to look for if we want to identify the next multi-bagger. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. So when we looked at Etsy (NASDAQ:ETSY) and its trend of ROCE, we really liked what we saw.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Etsy:

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

0.19 = US$376m ÷ (US$2.7b - US$711m) (Based on the trailing twelve months to December 2023).

Thus, Etsy has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Multiline Retail industry average of 12% it's much better.

Above you can see how the current ROCE for Etsy compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Etsy .

So How Is Etsy's ROCE Trending?

We like the trends that we're seeing from Etsy. The data shows that returns on capital have increased substantially over the last five years to 19%. Basically the business is earning more per dollar of capital invested and in addition to that, 150% more capital is being employed now too. So we're very much inspired by what we're seeing at Etsy thanks to its ability to profitably reinvest capital.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. The current liabilities has increased to 26% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.

The Key Takeaway

A company that is growing its returns on capital and can consistently reinvest in itself is a highly sought after trait, and that's what Etsy has. And given the stock has remained rather flat over the last five years, there might be an opportunity here if other metrics are strong. So researching this company further and determining whether or not these trends will continue seems justified.

On a final note, we found 3 warning signs for Etsy (1 is potentially serious) you should be aware of.

While Etsy 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.