Capital Allocation Trends At Valeo (EPA:FR) Aren't Ideal

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. Having said that, from a first glance at Valeo (EPA:FR) 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)

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. To calculate this metric for Valeo, this is the formula:

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

0.069 = €714m ÷ (€19b - €8.5b) (Based on the trailing twelve months to December 2021).

Therefore, Valeo has an ROCE of 6.9%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 10.0%.

See our latest analysis for Valeo

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

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at Valeo doesn't inspire confidence. To be more specific, ROCE has fallen from 16% over the last five years. 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 Valeo 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On Valeo's ROCE

To conclude, we've found that Valeo is reinvesting in the business, but returns have been falling. And in the last five years, the stock has given away 70% so the market doesn't look too hopeful on these trends strengthening any time soon. 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.

If you'd like to know about the risks facing Valeo, we've discovered 3 warning signs that you should be aware of.

While Valeo 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.