If we want to find a potential multi-bagger, often there are underlying trends that can provide clues. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at CarMax (NYSE:KMX) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
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. To calculate this metric for CarMax, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.069 = US$1.6b ÷ (US$26b - US$2.1b) (Based on the trailing twelve months to November 2021).
Therefore, CarMax has an ROCE of 6.9%. Ultimately, that's a low return and it under-performs the Specialty Retail industry average of 20%.
Above you can see how the current ROCE for CarMax 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 report for CarMax.
What Can We Tell From CarMax's ROCE Trend?
There are better returns on capital out there than what we're seeing at CarMax. The company has consistently earned 6.9% for the last five years, and the capital employed within the business has risen 60% in that time. Given the company has increased the amount of capital employed, it appears the investments that have been made simply don't provide a high return on capital.
The Key Takeaway
As we've seen above, CarMax's returns on capital haven't increased but it is reinvesting in the business. Since the stock has gained an impressive 62% over the last five years, investors must think there's better things to come. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
If you'd like to know more about CarMax, we've spotted 2 warning signs, and 1 of them doesn't sit too well with us.
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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