Carvana (NYSE:CVNA) Is Experiencing Growth In Returns On Capital

If you're looking for a multi-bagger, there's a few things to keep an eye out for. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in Carvana's (NYSE:CVNA) returns on capital, so let's have a look.

What Is Return On Capital Employed (ROCE)?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Carvana, this is the formula:

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

0.11 = US$695m ÷ (US$7.4b - US$1.2b) (Based on the trailing twelve months to September 2024).

Therefore, Carvana has an ROCE of 11%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 13%.

See our latest analysis for Carvana

In the above chart we have measured Carvana's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free analyst report for Carvana .

What The Trend Of ROCE Can Tell Us

Carvana has recently broken into profitability so their prior investments seem to be paying off. About five years ago the company was generating losses but things have turned around because it's now earning 11% on its capital. In addition to that, Carvana is employing 428% more capital than previously which is expected of a company that's trying to break into profitability. This can tell us that the company has plenty of reinvestment opportunities that are able to generate higher returns.

One more thing to note, Carvana has decreased current liabilities to 16% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

In Conclusion...

In summary, it's great to see that Carvana has managed to break into profitability and is continuing to reinvest in its business. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Carvana can keep these trends up, it could have a bright future ahead.

Carvana does have some risks, we noticed 3 warning signs (and 1 which is potentially serious) we think you should know about.

While Carvana 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.