U.S. markets close in 29 minutes
  • S&P 500

    3,930.91
    -10.35 (-0.26%)
     
  • Dow 30

    33,574.80
    -21.54 (-0.06%)
     
  • Nasdaq

    10,954.02
    -60.87 (-0.55%)
     
  • Russell 2000

    1,808.37
    -4.20 (-0.23%)
     
  • Crude Oil

    72.09
    -2.16 (-2.91%)
     
  • Gold

    1,800.40
    +18.00 (+1.01%)
     
  • Silver

    22.89
    +0.56 (+2.48%)
     
  • EUR/USD

    1.0510
    +0.0041 (+0.39%)
     
  • 10-Yr Bond

    3.4080
    -0.1050 (-2.99%)
     
  • GBP/USD

    1.2206
    +0.0073 (+0.60%)
     
  • USD/JPY

    136.3980
    -0.5620 (-0.41%)
     
  • BTC-USD

    16,823.01
    -148.77 (-0.88%)
     
  • CMC Crypto 200

    394.96
    -7.07 (-1.76%)
     
  • FTSE 100

    7,489.19
    -32.20 (-0.43%)
     
  • Nikkei 225

    27,686.40
    -199.47 (-0.72%)
     

Capital Allocation Trends At MercadoLibre (NASDAQ:MELI) Aren't Ideal

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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. However, after briefly looking over the numbers, we don't think MercadoLibre (NASDAQ:MELI) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

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 MercadoLibre is:

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

0.10 = US$497m ÷ (US$11b - US$6.2b) (Based on the trailing twelve months to March 2022).

Thus, MercadoLibre has an ROCE of 10%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Online Retail industry average of 12%.

Check out our latest analysis for MercadoLibre

roce
roce

In the above chart we have measured MercadoLibre'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.

What The Trend Of ROCE Can Tell Us

When we looked at the ROCE trend at MercadoLibre, we didn't gain much confidence. Over the last five years, returns on capital have decreased to 10% from 27% 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 side note, MercadoLibre's current liabilities have increased over the last five years to 57% of total assets, effectively distorting the ROCE to some degree. Without this increase, it's likely that ROCE would be even lower than 10%. What this means is that in reality, a rather large portion of the business is being funded by the likes of the company's suppliers or short-term creditors, which can bring some risks of its own.

The Bottom Line

While returns have fallen for MercadoLibre in recent times, we're encouraged to see that sales are growing and that the business is reinvesting in its operations. And long term investors must be optimistic going forward because the stock has returned a huge 181% to shareholders in the last five years. 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.

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

While MercadoLibre isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.