There Are Reasons To Feel Uneasy About Advance Auto Parts' (NYSE:AAP) Returns On Capital

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Advance Auto Parts (NYSE:AAP) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its 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)

0.089 = US$641m ÷ (US$12b - US$5.0b) (Based on the trailing twelve months to April 2023).

Therefore, Advance Auto Parts has an ROCE of 8.9%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 14%.

Check out 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 to see what analysts are forecasting going forward, you should check out our free report for Advance Auto Parts.

The Trend Of ROCE

When we looked at the ROCE trend at Advance Auto Parts, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 8.9% from 13% five years ago. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

On a side note, Advance Auto Parts' current liabilities are still rather high at 41% 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.

In Conclusion...

Bringing it all together, while we're somewhat encouraged by Advance Auto Parts' reinvestment in its own business, we're aware that returns are shrinking. And in the last five years, the stock has given away 40% so the market doesn't look too hopeful on these trends strengthening any time soon. Therefore based on the analysis done in this article, we don't think Advance Auto Parts has the makings of a multi-bagger.

One more thing, we've spotted 4 warning signs facing Advance Auto Parts that you might find interesting.

While Advance Auto Parts 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.