Volvo Car AB (publ.) (STO:VOLCAR B) Could Be Struggling To Allocate Capital

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. 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.

Understanding 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)

0.092 = kr17b ÷ (kr326b - kr138b) (Based on the trailing twelve months to March 2023).

Therefore, Volvo Car AB (publ.) has an ROCE of 9.2%. Ultimately, that's a low return and it under-performs the Auto industry average of 15%.

Check out our latest analysis for Volvo Car AB (publ.)

Above you can see how the current ROCE for Volvo Car AB (publ.) compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Volvo Car AB (publ.).

How Are Returns 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 9.2%. 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. If these investments prove successful, this can bode very well for long term stock performance.

Another thing to note, Volvo Car AB (publ.) has a high ratio of current liabilities to total assets of 42%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

The Bottom Line

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. And there could be an opportunity here if other metrics look good too, because the stock has declined 45% in the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

While Volvo Car AB (publ.) doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.

While Volvo Car AB (publ.) 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.