Returns On Capital At Zalando (ETR:ZAL) Have Stalled

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Zalando's (ETR:ZAL) ROCE trend, we were pretty happy with what we saw.

What is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Zalando:

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

0.12 = €437m ÷ (€6.8b - €3.0b) (Based on the trailing twelve months to September 2021).

Thus, Zalando has an ROCE of 12%. On its own, that's a standard return, however it's much better than the 5.3% generated by the Online Retail industry.

View our latest analysis for Zalando

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

What The Trend Of ROCE Can Tell Us

While the returns on capital are good, they haven't moved much. The company has employed 172% more capital in the last five years, and the returns on that capital have remained stable at 12%. Since 12% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

Another thing to note, Zalando has a high ratio of current liabilities to total assets of 45%. 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Zalando's ROCE

To sum it up, Zalando has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 108% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

Zalando does have some risks, we noticed 2 warning signs (and 1 which is a bit concerning) we think you should know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.