The Returns On Capital At Magazine Luiza (BVMF:MGLU3) Don't Inspire Confidence

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Magazine Luiza (BVMF:MGLU3) and its ROCE trend, we weren't exactly thrilled.

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. Analysts use this formula to calculate it for Magazine Luiza:

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

0.08 = R$1.1b ÷ (R$25b - R$11b) (Based on the trailing twelve months to June 2021).

Thus, Magazine Luiza has an ROCE of 8.0%. On its own that's a low return, but compared to the average of 6.6% generated by the Multiline Retail industry, it's much better.

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

What Does the ROCE Trend For Magazine Luiza Tell Us?

When we looked at the ROCE trend at Magazine Luiza, we didn't gain much confidence. Around five years ago the returns on capital were 17%, but since then they've fallen to 8.0%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

Another thing to note, Magazine Luiza has a high ratio of current liabilities to total assets of 46%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line On Magazine Luiza's ROCE

While returns have fallen for Magazine Luiza in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And the stock has done incredibly well with a 7,955% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a final note, we've found 2 warning signs for Magazine Luiza that we think 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.
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