JD Sports Fashion (LON:JD.) May Have Issues Allocating Its Capital

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing 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. Although, when we looked at JD Sports Fashion (LON:JD.), it didn't seem to tick all of these boxes.

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. Analysts use this formula to calculate it for JD Sports Fashion:

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

0.19 = UK£1.0b ÷ (UK£7.9b - UK£2.5b) (Based on the trailing twelve months to July 2023).

Therefore, 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.

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.

What The Trend Of ROCE Can Tell Us

In terms of JD Sports Fashion's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 27%, but since then they've fallen to 19%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, JD Sports Fashion has decreased its current liabilities to 32% 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. 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

While returns have fallen for JD Sports Fashion in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 136% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

JD Sports Fashion does have some risks though, and we've spotted 2 warning signs for JD Sports Fashion that you might be interested in.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.