To find a multi-bagger stock, what are the underlying trends we should look for in a business? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount 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. In light of that, when we looked at Advance Auto Parts (NYSE:AAP) and its ROCE trend, we weren't exactly thrilled.
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. The formula for this calculation on Advance Auto Parts is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$947m ÷ (US$12b - US$5.0b) (Based on the trailing twelve months to October 2021).
Thus, Advance Auto Parts has an ROCE of 14%. In absolute terms, that's a pretty standard return but compared to the Specialty Retail industry average it falls behind.
Above you can see how the current ROCE for Advance Auto Parts compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Does the ROCE Trend For Advance Auto Parts Tell Us?
In terms of Advance Auto Parts' historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 14% from 20% five years ago. 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. If these investments prove successful, this can bode very well for long term stock performance.
On a separate but related note, it's important to know that Advance Auto Parts has a current liabilities to total assets ratio of 42%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
In Conclusion...
While returns have fallen for Advance Auto Parts in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. Furthermore the stock has climbed 44% over the last five years, it would appear that investors are upbeat about the future. So while investors seem to be recognizing these promising trends, we would look further into this stock to make sure the other metrics justify the positive view.
While Advance Auto Parts doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
While Advance Auto Parts may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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