JD Sports Fashion's (LON:JD.) Returns On Capital Not Reflecting Well On The Business

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at JD Sports Fashion (LON:JD.) and its ROCE trend, we weren't exactly thrilled.

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. To calculate this metric for JD Sports Fashion, this is the formula:

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).

Therefore, JD Sports Fashion has an ROCE of 17%. On its own, that's a standard return, however it's much better than the 13% generated by the Specialty Retail industry.

See our latest analysis for JD Sports Fashion

In the above chart we have measured JD Sports Fashion's prior ROCE against its prior performance, but the future is arguably more important. 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

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. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. 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. 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 On JD Sports Fashion's ROCE

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 the stock has followed suit returning a meaningful 81% to shareholders over the last five years. 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.

If you want to continue researching JD Sports Fashion, you might be interested to know about the 2 warning signs that our analysis has discovered.

While JD Sports Fashion may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.