Linamar's (TSE:LNR) Returns On Capital Not Reflecting Well On The Business

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. Although, when we looked at Linamar (TSE:LNR), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Linamar is:

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

0.088 = CA$565m ÷ (CA$8.6b - CA$2.2b) (Based on the trailing twelve months to December 2022).

Therefore, Linamar has an ROCE of 8.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 8.7%.

Check out our latest analysis for Linamar

Above you can see how the current ROCE for Linamar 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 Linamar here for free.

The Trend Of ROCE

In terms of Linamar's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 8.8% from 16% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

What We Can Learn From Linamar's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Linamar. These trends don't appear to have influenced returns though, because the total return from the stock has been mostly flat over the last five years. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.

On a final note, we found 2 warning signs for Linamar (1 is a bit concerning) 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.