Be Wary Of Magazine Luiza (BVMF:MGLU3) And Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding 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 Magazine Luiza (BVMF:MGLU3) 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)?

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 Magazine Luiza:

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

0.083 = R$1.6b ÷ (R$37b - R$17b) (Based on the trailing twelve months to September 2023).

Therefore, Magazine Luiza has an ROCE of 8.3%. Even though it's in line with the industry average of 8.2%, it's still a low return by itself.

View our latest analysis for Magazine Luiza

Above you can see how the current ROCE for Magazine Luiza compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Magazine Luiza here for free.

What Can We Tell From Magazine Luiza's ROCE Trend?

On the surface, the trend of ROCE at Magazine Luiza doesn't inspire confidence. Around five years ago the returns on capital were 30%, but since then they've fallen to 8.3%. 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, Magazine Luiza's current liabilities are still rather high at 46% 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.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Magazine Luiza's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 59% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Magazine Luiza does have some risks though, and we've spotted 2 warning signs for Magazine Luiza that you might be interested in.

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.

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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.