ASOS (LON:ASC) Will Be Hoping To Turn Its Returns On Capital Around

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating ASOS (LON:ASC), we don't think it's current trends fit the mold of a multi-bagger.

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

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

0.039 = UK£76m ÷ (UK£2.9b - UK£960m) (Based on the trailing twelve months to February 2022).

Thus, ASOS has an ROCE of 3.9%. In absolute terms, that's a low return and it also under-performs the Online Retail industry average of 12%.

See our latest analysis for ASOS

Above you can see how the current ROCE for ASOS compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

On the surface, the trend of ROCE at ASOS doesn't inspire confidence. Around five years ago the returns on capital were 26%, but since then they've fallen to 3.9%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It may take some time before the company starts to see any change in earnings from these investments.

On a related note, ASOS has decreased its current liabilities to 33% of total assets. So we could link some of this to the decrease in ROCE. 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.

The Bottom Line On ASOS' ROCE

In summary, ASOS is reinvesting funds back into the business for growth but unfortunately it looks like sales haven't increased much just yet. Moreover, since the stock has crumbled 87% over the last five years, it appears investors are expecting the worst. Therefore based on the analysis done in this article, we don't think ASOS has the makings of a multi-bagger.

One more thing: We've identified 2 warning signs with ASOS (at least 1 which makes us a bit uncomfortable) , and understanding these would certainly be useful.

If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive 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.