Some Investors May Be Worried About MercadoLibre's (NASDAQ:MELI) Returns On Capital
If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. 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.
Return On Capital Employed (ROCE): What is it?
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. The formula for this calculation on MercadoLibre is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.12 = US$248m ÷ (US$5.2b - US$3.2b) (Based on the trailing twelve months to March 2021).
Therefore, MercadoLibre has an ROCE of 12%. That's a relatively normal return on capital, and it's around the 14% generated by the Online Retail industry.
View our latest analysis for MercadoLibre
In the above chart we have measured MercadoLibre's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for MercadoLibre.
What Can We Tell From MercadoLibre's ROCE Trend?
When we looked at the ROCE trend at MercadoLibre, we didn't gain much confidence. To be more specific, ROCE has fallen from 21% over the last five years. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. If these investments prove successful, this can bode very well for long term stock performance.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 62%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 12%. And with current liabilities at these levels, suppliers or short-term creditors are effectively funding a large part of the business, which can introduce some risks.
What We Can Learn From MercadoLibre's ROCE
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 the stock has done incredibly well with a 917% return over the last five years, so long term investors are no doubt ecstatic with that result. So should these growth trends continue, we'd be optimistic on the stock going forward.
If you'd like to know more about MercadoLibre, we've spotted 2 warning signs, and 1 of them makes us a bit uncomfortable.
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.
This article by Simply Wall St is general in nature. 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.
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