If we want to find a stock that can multiply over the long term, what are the underlying trends to look for? First, we want to see a proven return on capital employed (ROCE) that is increasing, and second, an expanding capital employed base. Simply put, these types of businesses are compounding machines, meaning they continually reinvest their profits at ever-higher rates of return. Although when we look JD sports fashion (LON:JD.), didn’t seem to check all of these boxes.
Return on Capital Employed (ROCE): What is it?
If you haven’t worked with ROCE before, it measures the ‘return’ (profit before tax) a company generates from the capital employed in its business. The formula for this calculation in JD Sports Fashion is:
Return on Capital Employed = Earnings Before Interest and Taxes (EBIT) ÷ (Total Assets – Current Liabilities)
0.17 = £968m ÷ (£7.7bn – £2bn) (based on the last twelve months to July 2022).
So, JD Sports Fashion has a ROCE of 17%. On its own, this is standard yield, however, it is much better than the 14% generated by the specialty retail industry.
See our latest review of JD Sports Fashion
Above you can see how JD Sports Fashion’s current ROCE compares to its past returns on equity, but there’s not much I can say about the past. If you are interested, you can see the analysts’ predictions in our free report on analyst forecasts for the company.
So how is JD Sports Fashion’s ROCE trend?
When we look at the ROCE trend in JD Sports Fashion, we don’t gain much confidence. About five years ago the return on equity was 38%, but has since fallen to 17%. However, as both capital employed and revenues have increased, it appears that the business is currently looking for growth, driven by short-term returns. If these investments are successful, this can bode well for long-term stock performance.
As a side note, JD Sports Fashion has done well to pay its current liabilities at 26% of total assets. So we could relate some of this to the decrease in ROCE. In addition, this may reduce some aspects of the risk to the business because fewer transactions are now financed by the company’s suppliers or short-term creditors. Since the company basically finances a greater part of its operations with its own money, it could be argued that this has made the company less efficient in generating ROCE.
The bottom line
In summary, despite the lower short-term returns, we are encouraged to see that JD Sports Fashion is reinvesting to grow and, as a result, having higher sales. And the stock has followed suit by returning a significant 43% to shareholders over the last five years. So if these growth trends continue, we would be bullish on stocks going forward.
If you want to know the risks that JD Sports Fashion faces, we have discovered 2 warning signs that you should take into account.
If you want to look for strong companies with big profits, check this out free list of companies with good balance sheets and impressive returns on capital.
Titration is complex, but we’re helping to simplify it.
Find out if JD Sports Fashion is potentially over- or undervalued by checking out our comprehensive analysis, including fair value estimates, risks and caveats, dividends, internal transactions and financial health.
See the free analysis
Do you have comments about this article? Concerned about the content? Get in touch with us directly. Alternatively, email the editorial team (at) Simplywallst.com.
This Simply Wall St article is of a general nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended as financial advice. It is not a recommendation to buy or sell any stock, and it does not take into account your goals or financial situation. Our goal is to provide you with long-term focused analysis driven by fundamental data. Please note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.
Source: news.google.com