There Are Reasons To Feel Uneasy About MercadoLibre's (NASDAQ:MELI) 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? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after investigating MercadoLibre (NASDAQ:MELI), 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. To calculate this metric for MercadoLibre, this is the formula:

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

0.13 = US$585m ÷ (US$11b - US$6.8b) (Based on the trailing twelve months to June 2022).

Therefore, MercadoLibre has an ROCE of 13%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Online Retail industry average of 12%.

Check out our latest analysis for MercadoLibre

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

What Does the ROCE Trend For MercadoLibre Tell Us?

In terms of MercadoLibre's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 26%, but since then they've fallen to 13%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. If these investments prove successful, this can bode very well for long term stock performance.

While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 60%, which has impacted the ROCE. If current liabilities hadn't increased as much as they did, the ROCE could actually be even lower. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line On MercadoLibre's ROCE

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for MercadoLibre. And long term investors must be optimistic going forward because the stock has returned a huge 358% 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.

If you'd like to know about the risks facing MercadoLibre, we've discovered 2 warning signs that you should be aware of.

While MercadoLibre isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.