Returns On Capital At Magazine Luiza (BVMF:MGLU3) Paint A Concerning Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. 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 Magazine Luiza (BVMF:MGLU3) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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

0.04 = R$924m ÷ (R$38b - R$15b) (Based on the trailing twelve months to December 2022).

So, Magazine Luiza has an ROCE of 4.0%. Ultimately, that's a low return and it under-performs the Multiline Retail industry average of 6.7%.

See 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 to see what analysts are forecasting going forward, you should check out our free report for Magazine Luiza.

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 4.0% from 25% five years ago. However it looks like Magazine Luiza might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. 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 39% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Key Takeaway

In summary, Magazine Luiza is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. And investors may be recognizing these trends since the stock has only returned a total of 11% to shareholders over the last five years. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

One final note, you should learn about the 2 warning signs we've spotted with Magazine Luiza (including 1 which makes us a bit uncomfortable) .

While Magazine Luiza isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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.