Some Investors May Be Worried About Valeo's (EPA:FR) Returns On Capital

There are a few key trends to look for if we want to identify the next multi-bagger. 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after investigating Valeo (EPA:FR), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Valeo:

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

0.097 = €980m ÷ (€18b - €8.3b) (Based on the trailing twelve months to June 2021).

So, Valeo has an ROCE of 9.7%. In absolute terms, that's a low return but it's around the Auto Components industry average of 11%.

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 to see what analysts are forecasting going forward, you should check out our free report for Valeo.

How Are Returns Trending?

When we looked at the ROCE trend at Valeo, we didn't gain much confidence. To be more specific, ROCE has fallen from 16% over the last five years. However it looks like Valeo might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.

On a side note, Valeo's current liabilities are still rather high at 45% of total assets. 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.

Our Take On Valeo's ROCE

Bringing it all together, while we're somewhat encouraged by Valeo's reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 46% so the market doesn't look too hopeful on these trends strengthening any time soon. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

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

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.
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