Some Investors May Be Worried About Zalando's (ETR:ZAL) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. Having said that, from a first glance at Zalando (ETR:ZAL) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

Understanding 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)

0.071 = €265m ÷ (€6.8b - €3.1b) (Based on the trailing twelve months to March 2022).

So, Zalando has an ROCE of 7.1%. On its own that's a low return, but compared to the average of 5.4% generated by the Online Retail industry, it's much better.

View our latest analysis for Zalando

In the above chart we have measured Zalando'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 Zalando here for free.

The Trend Of ROCE

When we looked at the ROCE trend at Zalando, we didn't gain much confidence. To be more specific, ROCE has fallen from 13% over the last five years. 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.

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

The Bottom Line

While returns have fallen for Zalando in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And there could be an opportunity here if other metrics look good too, because the stock has declined 35% in the last five years. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One final note, you should learn about the 3 warning signs we've spotted with Zalando (including 1 which doesn't sit too well with us) .

While Zalando may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.