Investors Could Be Concerned With JD Sports Fashion's (LON:JD.) Returns On Capital

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Although, when we looked at JD Sports Fashion (LON:JD.), it didn't seem to tick all of these boxes.

Return On Capital Employed (ROCE): What Is It?

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)

0.17 = UK£968m ÷ (UK£7.7b - UK£2.0b) (Based on the trailing twelve months to July 2022).

So, JD Sports Fashion has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 14% generated by the Specialty Retail industry.

View our latest analysis for JD Sports Fashion

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're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is JD Sports Fashion's ROCE Trending?

When we looked at the ROCE trend at JD Sports Fashion, we didn't gain much confidence. Around five years ago the returns on capital were 38%, but since then they've fallen to 17%. 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 26% 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. 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 followed suit returning a meaningful 43% to shareholders over the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

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

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.