What are the early trends we should look for to identify a stock that could multiply in value over the long term? 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. So when we looked at Sonic Automotive (NYSE:SAH) and its trend of ROCE, we really liked what we saw.
What is Return On Capital Employed (ROCE)?
If you haven’t worked with ROCE before, it measures the ‘return’ (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Sonic Automotive is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.19 = US$608m ÷ (US$5.0b – US$1.9b) (Based on the trailing twelve months to March 2022).
Thus, Sonic Automotive has a ROCE of 19%. In absolute terms, that’s a pretty normal return, and it’s somewhat close to the Specialty Retail industry average of 18%.
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.
So How Is Sonic Automotive’s ROCE Trending?
The trends we’ve noticed at Sonic Automotive are quite reassuring. Over the last five years, returns on capital employed have risen substantially to 19%. Basically the business is earning more per dollar of capital invested and in addition to that, 78% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that’s why we’re impressed.
In another part of our analysis, we noticed that the company’s ratio of current liabilities to total assets decreased to 37%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. So this improvement in ROCE has come from the business’ underlying economics, which is great to see.
The Key Takeaway
To sum it up, Sonic Automotive has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 116% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.
Since virtually every company faces some risks, it’s worth knowing what they are, and we’ve spotted 3 warning signs for Sonic Automotive (of which 2 are concerning!) that you should know about.
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. 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.