There Are Reasons To Feel Uneasy About Magazine Luiza's (BVMF:MGLU3) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. 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.

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

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. The formula for this calculation on Magazine Luiza is:

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

0.041 = R$886m ÷ (R$34b - R$13b) (Based on the trailing twelve months to March 2023).

So, Magazine Luiza has an ROCE of 4.1%. In absolute terms, that's a low return and it also under-performs the Multiline Retail industry average of 8.2%.

Check out 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.

So How Is Magazine Luiza's ROCE Trending?

When we looked at the ROCE trend at Magazine Luiza, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 4.1% from 26% 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 side note, Magazine Luiza has done well to pay down its current liabilities to 37% of total assets. So we could link some of this to the decrease in ROCE. 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.

The Bottom Line On Magazine Luiza's ROCE

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. Since the stock has declined 26% over the last five years, investors may not be too optimistic on this trend improving either. Therefore based on the analysis done in this article, we don't think Magazine Luiza has the makings of a multi-bagger.

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

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.