To find a multi-bagger stock, what are the underlying trends we should look for in a business? In a perfect world, we’d like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. Ultimately, this demonstrates that it’s a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at AutoNation (NYSE:AN) and its ROCE trend, we weren’t exactly thrilled.
Understanding 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. Analysts use this formula to calculate it for AutoNation:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.13 = US$758m ÷ (US$9.4b – US$3.8b) (Based on the trailing twelve months to June 2020).
Therefore, AutoNation has an ROCE of 13%. In absolute terms, that’s a satisfactory return, but compared to the Specialty Retail industry average of 9.5% it’s much better.
View our latest analysis for AutoNation
Above you can see how the current ROCE for AutoNation 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 AutoNation.
How Are Returns Trending?
On the surface, the trend of ROCE at AutoNation doesn’t inspire confidence. Around five years ago the returns on capital were 19%, but since then they’ve fallen to 13%. Meanwhile, the business is utilizing more capital but this hasn’t moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. 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.
On a side note, AutoNation’s current liabilities are still rather high at 40% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it’s not necessarily a bad thing, it can be beneficial if this ratio is lower.The Bottom Line
Bringing it all together, while we’re somewhat encouraged by AutoNation’s reinvestment in its own business, we’re aware that returns are shrinking. Unsurprisingly then, the total return to shareholders over the last five years has been flat. 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.
Like most companies, AutoNation does come with some risks, and we’ve found 3 warning signs that you should be aware of.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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