If you're looking for a multi-bagger, there's a few things to keep an eye out for. In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. That's why when we briefly looked at AutoNation's (NYSE:AN) ROCE trend, we were pretty happy with what we saw.
Return On Capital Employed (ROCE): What is it?
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. To calculate this metric for AutoNation, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = US$973m ÷ (US$9.9b - US$4.2b) (Based on the trailing twelve months to December 2020).
So, AutoNation has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 13% it's much better.
Above you can see how the current ROCE for AutoNation compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering AutoNation here for free.
What Can We Tell From AutoNation's ROCE Trend?
While the returns on capital are good, they haven't moved much. The company has employed 31% more capital in the last five years, and the returns on that capital have remained stable at 17%. 17% is a pretty standard return, and it provides some comfort knowing that AutoNation has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
On a side note, AutoNation has done well to reduce current liabilities to 42% of total assets over the last five years. Effectively suppliers now fund less of the business, which can lower some elements of risk. We'd like to see this trend continue though because as it stands today, thats still a pretty high level.
What We Can Learn From AutoNation's ROCE
To sum it up, AutoNation has simply been reinvesting capital steadily, at those decent rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
On a separate note, we've found 4 warning signs for AutoNation you'll probably want to know about.
While AutoNation 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.
If you’re looking to trade AutoNation, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
This article by Simply Wall St is general in nature. 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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.