Returns On Capital At Sonic Automotive (NYSE:SAH) Have Stalled

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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 Sonic Automotive (NYSE:SAH) and its ROCE trend, we weren't exactly thrilled.

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 Sonic Automotive, this is the formula:

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

0.16 = US$304m ÷ (US$3.7b - US$1.8b) (Based on the trailing twelve months to December 2020).

Thus, Sonic Automotive has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Specialty Retail industry average of 13% it's much better.

See our latest analysis for Sonic Automotive

In the above chart we have measured Sonic Automotive's 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 Sonic Automotive here for free.

How Are Returns Trending?

Things have been pretty stable at Sonic Automotive, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So unless we see a substantial change at Sonic Automotive in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger.

On a side note, Sonic Automotive's current liabilities are still rather high at 49% of total assets. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In summary, Sonic Automotive isn't compounding its earnings but is generating stable returns on the same amount of capital employed. Investors must think there's better things to come because the stock has knocked it out of the park, delivering a 207% gain to shareholders who have held over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.

On a final note, we've found 1 warning sign for Sonic Automotive that we think you should be aware of.

While Sonic Automotive 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. 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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