Investors Could Be Concerned With Lithia Motors' (NYSE:LAD) Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. In light of that, when we looked at Lithia Motors (NYSE:LAD) and its ROCE trend, we weren't exactly thrilled.

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Understanding Return On Capital Employed (ROCE)

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 Lithia Motors, this is the formula:

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

0.097 = US$1.6b ÷ (US$23b - US$6.6b) (Based on the trailing twelve months to March 2025).

Thus, Lithia Motors has an ROCE of 9.7%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

Check out our latest analysis for Lithia Motors

Above you can see how the current ROCE for Lithia Motors 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 Lithia Motors for free.

How Are Returns Trending?

In terms of Lithia Motors' historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 14%, but since then they've fallen to 9.7%. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a side note, Lithia Motors has done well to pay down its current liabilities to 28% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.

Our Take On Lithia Motors' ROCE

In summary, despite lower returns in the short term, we're encouraged to see that Lithia Motors is reinvesting for growth and has higher sales as a result. And the stock has done incredibly well with a 140% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

Like most companies, Lithia Motors does come with some risks, and we've found 1 warning sign that you should be aware of.

While Lithia Motors 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.