Returns On Capital Are Showing Encouraging Signs At Lookers (LON:LOOK)

Did you know there are some financial metrics that can provide clues of a potential 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Speaking of which, we noticed some great changes in Lookers' (LON:LOOK) returns on capital, so let's have a look.

Return On Capital Employed (ROCE): What is it?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Lookers:

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

0.19 = UK£121m ÷ (UK£1.5b - UK£886m) (Based on the trailing twelve months to June 2021).

Thus, Lookers has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 14% generated by the Specialty Retail industry.

Check out our latest analysis for Lookers

In the above chart we have measured Lookers' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lookers here for free.

How Are Returns Trending?

We like the trends that we're seeing from Lookers. The data shows that returns on capital have increased substantially over the last five years to 19%. Basically the business is earning more per dollar of capital invested and in addition to that, 22% more capital is being employed now too. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 58%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. This tells us that Lookers has grown its returns without a reliance on increasing their current liabilities, which we're very happy with. Nevertheless, there are some potential risks the company is bearing with current liabilities that high, so just keep that in mind.

The Bottom Line

All in all, it's terrific to see that Lookers is reaping the rewards from prior investments and is growing its capital base. Given the stock has declined 35% in the last five years, this could be a good investment if the valuation and other metrics are also appealing. With that in mind, we believe the promising trends warrant this stock for further investigation.

One more thing to note, we've identified 1 warning sign with Lookers and understanding this should be part of your investment process.

While Lookers 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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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.