Be Wary Of Advance Auto Parts (NYSE:AAP) And Its Returns On Capital

Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that's often how a mature business shows signs of aging. Ultimately this means that the company is earning less per dollar invested and on top of that, it's shrinking its base of capital employed. Having said that, after a brief look, Advance Auto Parts (NYSE:AAP) we aren't filled with optimism, but let's investigate further.

What Is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on Advance Auto Parts is:

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

0.02 = US$140m ÷ (US$12b - US$5.6b) (Based on the trailing twelve months to October 2024).

Thus, Advance Auto Parts has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

See our latest analysis for Advance Auto Parts

In the above chart we have measured Advance Auto Parts' 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 Advance Auto Parts for free.

What Does the ROCE Trend For Advance Auto Parts Tell Us?

There is reason to be cautious about Advance Auto Parts, given the returns are trending downwards. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Advance Auto Parts becoming one if things continue as they have.

On a side note, Advance Auto Parts' current liabilities are still rather high at 45% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

What We Can Learn From Advance Auto Parts' ROCE

In summary, it's unfortunate that Advance Auto Parts is generating lower returns from the same amount of capital. Investors haven't taken kindly to these developments, since the stock has declined 62% from where it was five years ago. That being the case, unless the underlying trends revert to a more positive trajectory, we'd consider looking elsewhere.

One final note, you should learn about the 3 warning signs we've spotted with Advance Auto Parts (including 1 which is concerning) .

While Advance Auto Parts may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.

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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.