Microsoft (NASDAQ:MSFT) Knows How To Allocate Capital Effectively
There are a few key trends to look for if we want to identify the next multi-bagger. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding 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, the ROCE of Microsoft (NASDAQ:MSFT) looks great, so lets see what the trend can tell us.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Microsoft, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.29 = US$107b ÷ (US$484b - US$119b) (Based on the trailing twelve months to March 2024).
Therefore, Microsoft has an ROCE of 29%. In absolute terms that's a great return and it's even better than the Software industry average of 7.5%.
View our latest analysis for Microsoft
Above you can see how the current ROCE for Microsoft 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 analyst report for Microsoft .
What Can We Tell From Microsoft's ROCE Trend?
Investors would be pleased with what's happening at Microsoft. Over the last five years, returns on capital employed have risen substantially to 29%. The amount of capital employed has increased too, by 75%. So we're very much inspired by what we're seeing at Microsoft thanks to its ability to profitably reinvest capital.
The Key Takeaway
In summary, it's great to see that Microsoft can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And a remarkable 249% total return over the last five years tells us that investors are expecting more good things to come in the future. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
Like most companies, Microsoft does come with some risks, and we've found 1 warning sign that you should be aware of.
Microsoft is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.
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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.
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