Some Investors May Be Worried About Sprouts Farmers Market's (NASDAQ:SFM) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. However, after briefly looking over the numbers, we don't think Sprouts Farmers Market (NASDAQ:SFM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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. To calculate this metric for Sprouts Farmers Market, this is the formula:

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

0.14 = US$376m ÷ (US$3.2b - US$515m) (Based on the trailing twelve months to April 2023).

Therefore, Sprouts Farmers Market has an ROCE of 14%. On its own, that's a standard return, however it's much better than the 12% generated by the Consumer Retailing industry.

View our latest analysis for Sprouts Farmers Market

In the above chart we have measured Sprouts Farmers Market's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Sprouts Farmers Market here for free.

So How Is Sprouts Farmers Market's ROCE Trending?

When we looked at the ROCE trend at Sprouts Farmers Market, we didn't gain much confidence. Around five years ago the returns on capital were 18%, but since then they've fallen to 14%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. 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 Sprouts Farmers Market is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 69% over the last five years, investors must think there's better things to come. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

Like most companies, Sprouts Farmers Market does come with some risks, and we've found 1 warning sign that you should be aware of.

While Sprouts Farmers Market 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.