Investors Met With Slowing Returns on Capital At Best Buy (NYSE:BBY)

What are the early trends we should look for to identify a stock that could multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at Best Buy (NYSE:BBY), it does have a high ROCE right now, but lets see how returns are trending.

Understanding 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. Analysts use this formula to calculate it for Best Buy:

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

0.35 = US$2.4b ÷ (US$15b - US$8.7b) (Based on the trailing twelve months to July 2022).

Thus, Best Buy has an ROCE of 35%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 17%.

Check out the opportunities and risks within the US Specialty Retail industry.

Above you can see how the current ROCE for Best Buy compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

What The Trend Of ROCE Can Tell Us

There hasn't been much to report for Best Buy's returns and its level of capital employed because both metrics have been steady for the past five years. This tells us the company isn't reinvesting in itself, so it's plausible that it's past the growth phase. So it may not be a multi-bagger in the making, but given the decent 35% return on capital, it'd be difficult to find fault with the business's current operations. This probably explains why Best Buy is paying out 43% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Another thing to note, Best Buy has a high ratio of current liabilities to total assets of 56%. 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.

The Bottom Line On Best Buy's ROCE

Although is allocating it's capital efficiently to generate impressive returns, it isn't compounding its base of capital, which is what we'd see from a multi-bagger. Unsurprisingly, the stock has only gained 30% over the last five years, which potentially indicates that investors are accounting for this going forward. So if you're looking for a multi-bagger, the underlying trends indicate you may have better chances elsewhere.

Best Buy does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those doesn't sit too well with us...

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.