Did you know there are some financial metrics that can provide clues of a potential multi-bagger? 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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So when we looked at Sonic Automotive (NYSE:SAH) and its trend of ROCE, we really liked what we saw.
Understanding 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. The formula for this calculation on Sonic Automotive is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.18 = US$346m ÷ (US$3.7b - US$1.8b) (Based on the trailing twelve months to March 2021).
Thus, Sonic Automotive has an ROCE of 18%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Specialty Retail industry average of 15%.NYSE:SAH Return on Capital Employed June 16th 2021
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 to see what analysts are forecasting going forward, you should check out our free report for Sonic Automotive.
So How Is Sonic Automotive's ROCE Trending?
Sonic Automotive has not disappointed with their ROCE growth. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 23% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
On a separate but related note, it's important to know that Sonic Automotive has a current liabilities to total assets ratio of 48%, 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.
What We Can Learn From Sonic Automotive's ROCE
In summary, we're delighted to see that Sonic Automotive has been able to increase efficiencies and earn higher rates of return on the same amount of capital. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. In light of that, we think it's worth looking further into this stock because if Sonic Automotive can keep these trends up, it could have a bright future ahead.
One more thing, we've spotted 1 warning sign facing Sonic Automotive that you might find interesting.
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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