Magazine Luiza (BVMF:MGLU3) Is Reinvesting At Lower Rates Of Return

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. However, after investigating Magazine Luiza (BVMF:MGLU3), we don't think it's current trends fit the mold of a multi-bagger.

What Is Return On Capital Employed (ROCE)?

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 Magazine Luiza, this is the formula:

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

0.018 = R$420m ÷ (R$36b - R$13b) (Based on the trailing twelve months to September 2022).

Thus, Magazine Luiza has an ROCE of 1.8%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 5.3%.

View our latest analysis for Magazine Luiza

In the above chart we have measured Magazine Luiza's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Magazine Luiza here for free.

So How Is Magazine Luiza's ROCE Trending?

In terms of Magazine Luiza's historical ROCE movements, the trend isn't fantastic. To be more specific, ROCE has fallen from 29% over the last five years. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, Magazine Luiza has decreased its current liabilities to 37% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

Our Take On Magazine Luiza's ROCE

To conclude, we've found that Magazine Luiza is reinvesting in the business, but returns have been falling. And with the stock having returned a mere 8.4% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

If you'd like to know about the risks facing Magazine Luiza, we've discovered 2 warning signs that you should be aware of.

While Magazine Luiza may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.