NEXT (LON:NXT) Might Be Having Difficulty Using Its Capital Effectively
What are the early trends we should look for to identify a stock that could multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So while NEXT (LON:NXT) has a high ROCE right now, lets see what we can decipher from how returns are changing.
Return On Capital Employed (ROCE): What Is It?
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for NEXT, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.34 = UK£960m ÷ (UK£4.0b - UK£1.2b) (Based on the trailing twelve months to July 2023).
Therefore, NEXT has an ROCE of 34%. In absolute terms that's a great return and it's even better than the Multiline Retail industry average of 8.7%.
See our latest analysis for NEXT
In the above chart we have measured NEXT'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 NEXT here for free.
How Are Returns Trending?
On the surface, the trend of ROCE at NEXT doesn't inspire confidence. To be more specific, while the ROCE is still high, it's fallen from 51% where it was five years ago. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
On a side note, NEXT has done well to pay down its current liabilities to 30% of total assets. So we could link some of this to the decrease in ROCE. Effectively this means their suppliers or short-term creditors are funding less of the business, which reduces some elements of risk. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
The Bottom Line On NEXT's ROCE
To conclude, we've found that NEXT is reinvesting in the business, but returns have been falling. Although the market must be expecting these trends to improve because the stock has gained 99% over the last five years. Ultimately, if the underlying trends persist, we wouldn't hold our breath on it being a multi-bagger going forward.
On a separate note, we've found 3 warning signs for NEXT you'll probably want to know about.
If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning high returns on equity.
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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.
