Capital Allocation Trends At JD Sports Fashion (LON:JD.) Aren't Ideal

By
Simply Wall St
Published
November 19, 2021
LSE:JD.
Source: Shutterstock

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. 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 JD Sports Fashion (LON:JD.), we don't think it's current trends fit the mold of a multi-bagger.

What is 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. The formula for this calculation on JD Sports Fashion is:

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

0.19 = UK£868m ÷ (UK£6.5b - UK£1.8b) (Based on the trailing twelve months to July 2021).

Thus, JD Sports Fashion has an ROCE of 19%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 14% it's much better.

See our latest analysis for JD Sports Fashion

roce
LSE:JD. Return on Capital Employed November 20th 2021

Above you can see how the current ROCE for JD Sports Fashion 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 JD Sports Fashion.

What Does the ROCE Trend For JD Sports Fashion Tell Us?

When we looked at the ROCE trend at JD Sports Fashion, we didn't gain much confidence. To be more specific, ROCE has fallen from 38% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.

On a side note, JD Sports Fashion has done well to pay down its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. 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.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that JD Sports Fashion is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 270% return over the last five years, so long term investors are no doubt ecstatic with that result. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.

JD Sports Fashion does have some risks though, and we've spotted 1 warning sign for JD Sports Fashion that you might be interested in.

While JD Sports Fashion 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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