The Returns On Capital At Lithia Motors (NYSE:LAD) Don't Inspire Confidence

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. However, after investigating Lithia Motors (NYSE:LAD), we don't think it's current trends fit the mold of a multi-bagger.

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. Analysts use this formula to calculate it for Lithia Motors:

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

0.094 = US$1.6b ÷ (US$23b - US$6.7b) (Based on the trailing twelve months to September 2024).

Therefore, Lithia Motors has an ROCE of 9.4%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 13%.

View 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 for free.

What The Trend Of ROCE Can Tell Us

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 9.4% from 15% five years ago. 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 related note, Lithia Motors has decreased its current liabilities to 29% of total assets. So we could link some of this to the decrease in ROCE. 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

Even though returns on capital have fallen in the short term, we find it promising that revenue and capital employed have both increased for Lithia Motors. And long term investors must be optimistic going forward because the stock has returned a huge 146% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know more about Lithia Motors, we've spotted 3 warning signs, and 1 of them can't be ignored.

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.