Slowing Rates Of Return At Lithia Motors (NYSE:LAD) Leave Little Room For Excitement

Did you know there are some financial metrics that can provide clues of a potential 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. That's why when we briefly looked at Lithia Motors' (NYSE:LAD) ROCE trend, we were pretty happy with what we saw.

Return On Capital Employed (ROCE): What Is It?

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 Lithia Motors, this is the formula:

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

0.13 = US$1.8b ÷ (US$18b - US$4.0b) (Based on the trailing twelve months to June 2023).

Therefore, Lithia Motors has an ROCE of 13%. That's a pretty standard return and it's in line with the industry average of 13%.

Check out 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 to see what analysts are forecasting going forward, you should check out our free report for Lithia Motors.

What The Trend Of ROCE Can Tell Us

While the current returns on capital are decent, they haven't changed much. Over the past five years, ROCE has remained relatively flat at around 13% and the business has deployed 395% more capital into its operations. 13% is a pretty standard return, and it provides some comfort knowing that Lithia Motors has consistently earned this amount. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.

On a side note, Lithia Motors has done well to reduce current liabilities to 23% 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.

What We Can Learn From Lithia Motors' ROCE

To sum it up, Lithia Motors has simply been reinvesting capital steadily, at those decent rates of return. And the stock has done incredibly well with a 256% return over the last five years, so long term investors are no doubt ecstatic with that result. So even though the stock might be more "expensive" than it was before, we think the strong fundamentals warrant this stock for further research.

One final note, you should learn about the 2 warning signs we've spotted with Lithia Motors (including 1 which is potentially serious) .

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.