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Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. 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. So when we looked at LKQ (NASDAQ:LKQ) and its trend of ROCE, we really liked what we saw.
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. The formula for this calculation on LKQ is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$1.4b ÷ (US$12b - US$2.3b) (Based on the trailing twelve months to June 2021).
So, LKQ has an ROCE of 14%. By itself that's a normal return on capital and it's in line with the industry's average returns of 14%.
Above you can see how the current ROCE for LKQ compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for LKQ.
So How Is LKQ's ROCE Trending?
We like the trends that we're seeing from LKQ. Over the last five years, returns on capital employed have risen substantially to 14%. The amount of capital employed has increased too, by 45%. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, a combination that's common among multi-baggers.
The Bottom Line On LKQ's ROCE
To sum it up, LKQ has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 41% return over the last five years. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing, we've spotted 1 warning sign facing LKQ that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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.
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