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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Advance Auto Parts (NYSE:AAP) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
What Is Return On Capital Employed (ROCE)?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Advance Auto Parts is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.055 = US$391m ÷ (US$12b - US$5.1b) (Based on the trailing twelve months to October 2023).
So, Advance Auto Parts has an ROCE of 5.5%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.
In the above chart we have measured Advance Auto Parts' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Advance Auto Parts' ROCE Trending?
When we looked at the ROCE trend at Advance Auto Parts, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.5% from 13% five years ago. However it looks like Advance Auto Parts might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.
Another thing to note, Advance Auto Parts has a high ratio of current liabilities to total assets of 42%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Advance Auto Parts' ROCE
Bringing it all together, while we're somewhat encouraged by Advance Auto Parts' reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 57% so the market doesn't look too hopeful on these trends strengthening any time soon. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.
Since virtually every company faces some risks, it's worth knowing what they are, and we've spotted 3 warning signs for Advance Auto Parts (of which 2 make us uncomfortable!) that you should know about.
While Advance Auto Parts 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.