Returns On Capital At Advance Auto Parts (NYSE:AAP) Paint A Concerning Picture

To avoid investing in a business that's in decline, there's a few financial metrics that can provide early indications of aging. 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. This indicates the company is producing less profit from its investments and its total assets are decreasing. So after glancing at the trends within Advance Auto Parts (NYSE:AAP), we weren't too hopeful.

What Is 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. Analysts use this formula to calculate it for Advance Auto Parts:

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

0.0069 = US$48m ÷ (US$12b - US$5.3b) (Based on the trailing twelve months to July 2024).

Thus, Advance Auto Parts has an ROCE of 0.7%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 12%.

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 Can We Tell From Advance Auto Parts' ROCE Trend?

In terms of Advance Auto Parts' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. 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 43% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

Our Take On Advance Auto Parts' ROCE

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. This could explain why the stock has sunk a total of 71% in the last five years. With underlying trends that aren't great in these areas, we'd consider looking elsewhere.

One final note, you should learn about the 2 warning signs we've spotted with Advance Auto Parts (including 1 which makes us a bit uncomfortable) .

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.