There Are Reasons To Feel Uneasy About JD Sports Fashion's (LON:JD.) Returns On Capital
If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. 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 JD Sports Fashion (LON:JD.) 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?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. To calculate this metric for JD Sports Fashion, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.19 = UK£1.0b ÷ (UK£7.9b - UK£2.5b) (Based on the trailing twelve months to July 2023).
Thus, JD Sports Fashion has an ROCE of 19%. On its own, that's a standard return, however it's much better than the 14% generated by the Specialty Retail industry.
Check out our latest analysis for JD Sports Fashion
Above you can see how the current ROCE for JD Sports Fashion compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
What Can We Tell From JD Sports Fashion's ROCE Trend?
On the surface, the trend of ROCE at JD Sports Fashion doesn't inspire confidence. Over the last five years, returns on capital have decreased to 19% from 27% five years ago. 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.
On a side note, JD Sports Fashion has done well to pay down its current liabilities to 32% 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. Some would claim this reduces the business' efficiency at generating ROCE since it is now funding more of the operations with its own money.
What We Can Learn From JD Sports Fashion's ROCE
In summary, despite lower returns in the short term, we're encouraged to see that JD Sports Fashion is reinvesting for growth and has higher sales as a result. And long term investors must be optimistic going forward because the stock has returned a huge 165% to shareholders in the last five years. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.
On a final note, we've found 2 warning signs for JD Sports Fashion that we think you should be aware of.
While JD Sports Fashion isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.
