Returns At Leon's Furniture (TSE:LNF) Are On The Way Up

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Leon's Furniture's (TSE:LNF) returns on capital, so let's have a look.

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. Analysts use this formula to calculate it for Leon's Furniture:

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

0.15 = CA$212m ÷ (CA$2.2b - CA$754m) (Based on the trailing twelve months to June 2023).

Thus, Leon's Furniture has an ROCE of 15%. That's a relatively normal return on capital, and it's around the 14% generated by the Specialty Retail industry.

Check out our latest analysis for Leon's Furniture

In the above chart we have measured Leon's Furniture's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Leon's Furniture here for free.

So How Is Leon's Furniture's ROCE Trending?

Leon's Furniture's ROCE growth is quite impressive. The figures show that over the last five years, ROCE has grown 25% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.

For the record though, there was a noticeable increase in the company's current liabilities over the period, so we would attribute some of the ROCE growth to that. Essentially the business now has suppliers or short-term creditors funding about 35% of its operations, which isn't ideal. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.

The Bottom Line On Leon's Furniture's ROCE

As discussed above, Leon's Furniture appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. Since the stock has only returned 20% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. So exploring more about this stock could uncover a good opportunity, if the valuation and other metrics stack up.

If you'd like to know about the risks facing Leon's Furniture, we've discovered 1 warning sign 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.