Here's What To Make Of Inchcape's (LON:INCH) Decelerating Rates Of Return

Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. So when we looked at Inchcape (LON:INCH), they do have a high ROCE, but we weren't exactly elated from how returns are trending.

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 Inchcape is:

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

0.20 = UK£364m ÷ (UK£4.0b - UK£2.2b) (Based on the trailing twelve months to June 2022).

Therefore, Inchcape has an ROCE of 20%. In absolute terms that's a great return and it's even better than the Retail Distributors industry average of 14%.

See our latest analysis for Inchcape

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

So How Is Inchcape's ROCE Trending?

There hasn't been much to report for Inchcape's returns and its level of capital employed because both metrics have been steady for the past five years. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So it may not be a multi-bagger in the making, but given the decent 20% return on capital, it'd be difficult to find fault with the business's current operations. With fewer investment opportunities, it makes sense that Inchcape has been paying out a decent 50% of its earnings to shareholders. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Another thing to note, Inchcape has a high ratio of current liabilities to total assets of 54%. 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 Inchcape's ROCE

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. And investors may be recognizing these trends since the stock has only returned a total of 3.8% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

If you'd like to know about the risks facing Inchcape, we've discovered 2 warning signs that you should be aware of.

Inchcape is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.