Fnac Darty (EPA:FNAC) Is Reinvesting At Lower Rates Of Return

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. In light of that, when we looked at Fnac Darty (EPA:FNAC) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. The formula for this calculation on Fnac Darty is:

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

0.059 = €215m ÷ (€7.1b - €3.5b) (Based on the trailing twelve months to December 2020).

Therefore, Fnac Darty has an ROCE of 5.9%. Even though it's in line with the industry average of 6.4%, it's still a low return by itself.

Check out our latest analysis for Fnac Darty

In the above chart we have measured Fnac Darty's 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 Fnac Darty.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at Fnac Darty, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 5.9% from 13% five years ago. However it looks like Fnac Darty 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, Fnac Darty has done well to pay down its current liabilities to 49% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE. Either way, they're still at a pretty high level, so we'd like to see them fall further if possible.

What We Can Learn From Fnac Darty's ROCE

Bringing it all together, while we're somewhat encouraged by Fnac Darty's reinvestment in its own business, we're aware that returns are shrinking. And with the stock having returned a mere 4.0% in the last five years to shareholders, you could argue that they're aware of these lackluster trends. Therefore, if you're looking for a multi-bagger, we'd propose looking at other options.

On a final note, we've found 2 warning signs for Fnac Darty that we think you should be aware of.

While Fnac Darty isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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