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If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. With that in mind, the ROCE of Sonic Automotive (NYSE:SAH) looks great, so lets see what the trend can tell us.
What is Return On Capital Employed (ROCE)?
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 Sonic Automotive, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.23 = US$457m ÷ (US$3.7b - US$1.6b) (Based on the trailing twelve months to June 2021).
So, Sonic Automotive has an ROCE of 23%. In absolute terms that's a great return and it's even better than the Specialty Retail industry average of 17%.
In the above chart we have measured Sonic Automotive'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 Sonic Automotive here for free.
What Can We Tell From Sonic Automotive's ROCE Trend?
Investors would be pleased with what's happening at Sonic Automotive. Over the last five years, returns on capital employed have risen substantially to 23%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 20%. 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.
On a separate but related note, it's important to know that Sonic Automotive has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. Ideally we'd like to see this reduce as that would mean fewer obligations bearing risks.
The Bottom Line
All in all, it's terrific to see that Sonic Automotive is reaping the rewards from prior investments and is growing its capital base. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
If you'd like to know about the risks facing Sonic Automotive, we've discovered 2 warning signs that you should be aware of.
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.
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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