Returns On Capital Signal Tricky Times Ahead For Volvo Car AB (publ.) (STO:VOLCAR B)

There are a few key trends to look for if we want to identify the next 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. However, after investigating Volvo Car AB (publ.) (STO:VOLCAR B), we don't think it's current trends fit the mold of a multi-bagger.

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. The formula for this calculation on Volvo Car AB (publ.) is:

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

0.10 = kr19b ÷ (kr343b - kr158b) (Based on the trailing twelve months to June 2023).

Therefore, Volvo Car AB (publ.) has an ROCE of 10%. In absolute terms, that's a pretty standard return but compared to the Auto industry average it falls behind.

See our latest analysis for Volvo Car AB (publ.)

In the above chart we have measured Volvo Car AB (publ.)'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.

So How Is Volvo Car AB (publ.)'s ROCE Trending?

On the surface, the trend of ROCE at Volvo Car AB (publ.) doesn't inspire confidence. Around five years ago the returns on capital were 14%, but since then they've fallen to 10%. 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. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a separate but related note, it's important to know that Volvo Car AB (publ.) has a current liabilities to total assets ratio of 46%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Volvo Car AB (publ.) is reinvesting for growth and has higher sales as a result. However, total returns to shareholders over the last year have been flat, which could indicate these growth trends potentially aren't accounted for yet by investors. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

One more thing, we've spotted 1 warning sign facing Volvo Car AB (publ.) that you might find interesting.

While Volvo Car AB (publ.) isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.