LF's (KRX:093050) Returns On Capital Not Reflecting Well On The Business

There are a few key trends to look for if we want to identify the next multi-bagger. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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 LF (KRX:093050), it didn't seem to tick all of these boxes.

Understanding Return On Capital Employed (ROCE)

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for LF, this is the formula:

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

0.044 = ₩77b ÷ (₩2.5t - ₩721b) (Based on the trailing twelve months to December 2020).

Therefore, LF has an ROCE of 4.4%. In absolute terms, that's a low return and it also under-performs the Luxury industry average of 7.4%.

View our latest analysis for LF

Above you can see how the current ROCE for LF 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 LF's ROCE Trending?

When we looked at the ROCE trend at LF, we didn't gain much confidence. To be more specific, ROCE has fallen from 6.2% over the last five years. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 29%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 4.4%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.

The Key Takeaway

In summary, we're somewhat concerned by LF's diminishing returns on increasing amounts of capital. Long term shareholders who've owned the stock over the last five years have experienced a 19% depreciation in their investment, so it appears the market might not like these trends either. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

On a final note, we've found 3 warning signs for LF that we think you should be aware of.

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This article by Simply Wall St is general in nature. 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.
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