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What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. With that in mind, the ROCE of Inchcape (LON:INCH) looks decent, right now, so lets see what the trend of returns can tell us.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Inchcape, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = UK£539m ÷ (UK£6.7b - UK£3.5b) (Based on the trailing twelve months to June 2023).
Thus, Inchcape has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Retail Distributors industry average of 14% it's much better.
Check out our latest analysis for Inchcape
In the above chart we have measured Inchcape'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 Inchcape here for free.
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven't changed much. The company has employed 63% more capital in the last five years, and the returns on that capital have remained stable at 17%. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
Another thing to note, Inchcape has a high ratio of current liabilities to total assets of 52%. 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. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
The main thing to remember is that Inchcape has proven its ability to continually reinvest at respectable rates of return. Therefore it's no surprise that shareholders have earned a respectable 52% return if they held over the last five years. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.