Some Investors May Be Worried About Axfood's (STO:AXFO) Returns On Capital

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while Axfood (STO:AXFO) has a high ROCE right now, lets see what we can decipher from how returns are changing.

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. To calculate this metric for Axfood, this is the formula:

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

0.25 = kr3.2b ÷ (kr24b - kr12b) (Based on the trailing twelve months to September 2022).

So, Axfood has an ROCE of 25%. That's a fantastic return and not only that, it outpaces the average of 11% earned by companies in a similar industry.

Our analysis indicates that AXFO is potentially undervalued!

Above you can see how the current ROCE for Axfood compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Axfood here for free.

How Are Returns Trending?

When we looked at the ROCE trend at Axfood, we didn't gain much confidence. Historically returns on capital were even higher at 35%, but they have dropped over the last five years. 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, Axfood has a high ratio of current liabilities to total assets of 48%. 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.

In Conclusion...

In summary, despite lower returns in the short term, we're encouraged to see that Axfood is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 111% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Axfood does have some risks though, and we've spotted 1 warning sign for Axfood that you might be interested in.

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.

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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.