Here's What's Concerning About Lear's (NYSE:LEA) Returns On Capital

If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. 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. In light of that, when we looked at Lear (NYSE:LEA) and its ROCE trend, we weren't exactly thrilled.

Return On Capital Employed (ROCE): What Is It?

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

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

0.11 = US$969m ÷ (US$15b - US$5.7b) (Based on the trailing twelve months to September 2023).

Thus, Lear has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 13% generated by the Auto Components industry.

See our latest analysis for Lear

Above you can see how the current ROCE for Lear 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 Lear.

What Can We Tell From Lear's ROCE Trend?

On the surface, the trend of ROCE at Lear doesn't inspire confidence. Around five years ago the returns on capital were 24%, but since then they've fallen to 11%. 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.

What We Can Learn From Lear's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Lear is reinvesting for growth and has higher sales as a result. In light of this, the stock has only gained 4.9% over the last five years. So this stock may still be an appealing investment opportunity, if other fundamentals prove to be sound.

One more thing to note, we've identified 2 warning signs with Lear and understanding these should be part of your investment process.

While Lear 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.