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. 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. In light of that, when we looked at CarMax (NYSE:KMX) and its ROCE trend, we weren't exactly thrilled.
Return On Capital Employed (ROCE): What Is It?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for CarMax, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.031 = US$769m ÷ (US$27b - US$2.1b) (Based on the trailing twelve months to November 2023).
So, CarMax has an ROCE of 3.1%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.
Above you can see how the current ROCE for CarMax 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 CarMax .
So How Is CarMax's ROCE Trending?
On the surface, the trend of ROCE at CarMax doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.1% from 6.7% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.
The Key Takeaway
From the above analysis, we find it rather worrisome that returns on capital and sales for CarMax have fallen, meanwhile the business is employing more capital than it was five years ago. Investors must expect better things on the horizon though because the stock has risen 22% in the last five years. Either way, we aren't huge fans of the current trends and so with that we think you might find better investments elsewhere.
If you want to continue researching CarMax, you might be interested to know about the 1 warning sign that our analysis has discovered.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.