Lithia Motors (NYSE:LAD) Is Reinvesting At Lower Rates Of Return

There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. In light of that, when we looked at Lithia Motors (NYSE:LAD) and its ROCE trend, we weren't exactly thrilled.

What Is Return On Capital Employed (ROCE)?

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. Analysts use this formula to calculate it for Lithia Motors:

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

0.11 = US$1.7b ÷ (US$22b - US$6.6b) (Based on the trailing twelve months to March 2024).

Therefore, Lithia Motors has an ROCE of 11%. That's a relatively normal return on capital, and it's around the 13% generated by the Specialty Retail industry.

View 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.

The Trend Of ROCE

When we looked at the ROCE trend at Lithia Motors, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 11% from 15% five years ago. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. 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 30% of total assets. That could partly explain why the ROCE has dropped. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. 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.

What We Can Learn From Lithia Motors' ROCE

While returns have fallen for Lithia Motors in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 120% to shareholders in the last five years. So should these growth trends continue, we'd be optimistic on the stock going forward.

On a separate note, we've found 1 warning sign for Lithia Motors you'll probably want to know about.

For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high returns on equity.

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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.

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