Advance Auto Parts (NYSE:AAP) Will Be Hoping To Turn Its Returns On Capital Around
When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after glancing at the trends within Advance Auto Parts (NYSE:AAP), we weren't too hopeful.
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 Advance Auto Parts is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.015 = US$102m ÷ (US$12b - US$5.2b) (Based on the trailing twelve months to April 2024).
Therefore, Advance Auto Parts has an ROCE of 1.5%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 12%.
Check out our latest analysis for Advance Auto Parts
Above you can see how the current ROCE for Advance Auto Parts 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 analyst report for Advance Auto Parts .
What Can We Tell From Advance Auto Parts' ROCE Trend?
There is reason to be cautious about Advance Auto Parts, given the returns are trending downwards. About five years ago, returns on capital were 11%, however they're now substantially lower than that as we saw above. On top of that, it's worth noting that the amount of capital employed within the business has remained relatively steady. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Advance Auto Parts becoming one if things continue as they have.
On a separate but related note, it's important to know that Advance Auto Parts has a current liabilities to total assets ratio of 43%, which we'd consider pretty high. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Bottom Line On Advance Auto Parts' ROCE
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. It should come as no surprise then that the stock has fallen 56% over the last five years, so it looks like investors are recognizing these changes. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.
Advance Auto Parts does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.
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