Magazine Luiza (BVMF:MGLU3) Will Be Hoping To Turn Its Returns On Capital Around

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. Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. However, after briefly looking over the numbers, we don't think Magazine Luiza (BVMF:MGLU3) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed 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)

0.038 = R$779m ÷ (R$36b - R$15b) (Based on the trailing twelve months to June 2023).

Thus, Magazine Luiza has an ROCE of 3.8%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 6.8%.

Check out 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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Magazine Luiza doesn't inspire confidence. Over the last five years, returns on capital have decreased to 3.8% from 29% five years ago. 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'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 related note, Magazine Luiza has decreased its current liabilities to 43% 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. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Keep in mind 43% is still pretty high, so those risks are still somewhat prevalent.

What We Can Learn From Magazine Luiza's ROCE

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 investors may be expecting the fundamentals to get a lot worse because the stock has crashed 70% over the last five years. 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.

One final note, you should learn about the 2 warning signs we've spotted with Magazine Luiza (including 1 which can't be ignored) .

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.