To find a multi-bagger stock, what are the underlying trends we should look for in a business? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. 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)
0.091 = US$749m ÷ (US$13b - US$5.2b) (Based on the trailing twelve months to April 2021).
Therefore, Lear has an ROCE of 9.1%. In absolute terms, that's a low return but it's around the Auto Components industry average of 11%.
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 Does the ROCE Trend For Lear Tell Us?
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 9.1%. However it looks like Lear might be reinvesting for long term growth because while capital employed has increased, the company's sales haven't changed much in the last 12 months. It may take some time before the company starts to see any change in earnings from these investments.
The Key Takeaway
To conclude, we've found that Lear is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 77% over the last five years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
On a separate note, we've found 4 warning signs for Lear you'll probably want to know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.
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