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Investors Could Be Concerned With JD Sports Fashion's (LON:JD.) Returns On Capital

·3-min read

If you're looking for a multi-bagger, there's a few things to keep an eye out 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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Looking at JD Sports Fashion (LON:JD.), it does have a high ROCE right now, but lets see how returns are trending.

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. Analysts use this formula to calculate it for JD Sports Fashion:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = UK£1.0b ÷ (UK£7.1b - UK£1.9b) (Based on the trailing twelve months to January 2022).

So, JD Sports Fashion has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 14% earned by companies in a similar industry.

View our latest analysis for JD Sports Fashion

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In the above chart we have measured JD Sports Fashion's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

So How Is JD Sports Fashion's ROCE Trending?

When we looked at the ROCE trend at JD Sports Fashion, we didn't gain much confidence. While it's comforting that the ROCE is high, five years ago it was 38%. Although, given both revenue and the amount of assets employed in the business have increased, it could suggest the company is investing in growth, and the extra capital has led to a short-term reduction in ROCE. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

On a related note, JD Sports Fashion has decreased its current liabilities to 27% 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.

The Bottom Line On 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 the stock has followed suit returning a meaningful 91% to shareholders over 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 separate note, we've found 1 warning sign for JD Sports Fashion you'll probably want to know about.

JD Sports Fashion is not the only stock earning high returns. If you'd like to see more, check out our free list of companies earning high returns on equity with solid fundamentals.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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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