There Are Reasons To Feel Uneasy About Karooooo's (NASDAQ:KARO) Returns On Capital

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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Looking at Karooooo (NASDAQ:KARO), it does have a high ROCE right now, but lets see how returns are trending.

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. Analysts use this formula to calculate it for Karooooo:

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

0.28 = R699m ÷ (R3.1b - R624m) (Based on the trailing twelve months to February 2022).

Thus, Karooooo has an ROCE of 28%. In absolute terms that's a great return and it's even better than the Software industry average of 9.3%.

View our latest analysis for Karooooo

In the above chart we have measured Karooooo's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

On the surface, the trend of ROCE at Karooooo doesn't inspire confidence. While it's comforting that the ROCE is high, three years ago it was 43%. 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.

Our Take On Karooooo's ROCE

While returns have fallen for Karooooo in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. These growth trends haven't led to growth returns though, since the stock has fallen 21% over the last year. So we think it'd be worthwhile to look further into this stock given the trends look encouraging.

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

Karooooo is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

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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.