Returns On Capital At adidas (ETR:ADS) 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? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating adidas (ETR:ADS), we don't think it's current trends fit the mold of a multi-bagger.

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 adidas, this is the formula:

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

0.13 = €1.6b ÷ (€21b - €9.6b) (Based on the trailing twelve months to June 2022).

So, adidas has an ROCE of 13%. On its own, that's a standard return, however it's much better than the 10% generated by the Luxury industry.

Check out the opportunities and risks within the DE Luxury industry.

In the above chart we have measured adidas' 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 adidas.

How Are Returns Trending?

When we looked at the ROCE trend at adidas, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 13% from 21% five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.

On a separate but related note, it's important to know that adidas has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

What We Can Learn From adidas' ROCE

Bringing it all together, while we're somewhat encouraged by adidas' reinvestment in its own business, we're aware that returns are shrinking. Since the stock has declined 27% over the last five years, investors may not be too optimistic on this trend improving either. All in all, the inherent trends aren't typical of multi-baggers, so if that's what you're after, we think you might have more luck elsewhere.

adidas does have some risks though, and we've spotted 2 warning signs for adidas that you might be interested in.

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.