Lithia Motors' (NYSE:LAD) Returns Have Hit A Wall

If you're not sure where to start when looking for the next multi-bagger, there are a few key trends you should 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. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Lithia Motors (NYSE:LAD) looks decent, right now, so lets see what the trend of returns can tell us.

What Is 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. The formula for this calculation on Lithia Motors is:

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

0.18 = US$2.1b ÷ (US$14b - US$2.8b) (Based on the trailing twelve months to September 2022).

So, Lithia Motors has an ROCE of 18%. That's a relatively normal return on capital, and it's around the 17% generated by the Specialty Retail industry.

See our latest analysis for Lithia Motors

In the above chart we have measured Lithia Motors' prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Lithia Motors here for free.

How Are Returns Trending?

While the returns on capital are good, they haven't moved much. Over the past five years, ROCE has remained relatively flat at around 18% and the business has deployed 390% more capital into its operations. Since 18% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Stable returns in this ballpark can be unexciting, but if they can be maintained over the long run, they often provide nice rewards to shareholders.

On a side note, Lithia Motors has done well to reduce current liabilities to 20% of total assets over the last five years. This can eliminate some of the risks inherent in the operations because the business has less outstanding obligations to their suppliers and or short-term creditors than they did previously.

The Bottom Line

To sum it up, Lithia Motors has simply been reinvesting capital steadily, at those decent rates of return. And long term investors would be thrilled with the 152% return they've received over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

On a final note, we've found 2 warning signs for Lithia Motors that we think you should be aware of.

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.