When it comes to investing, there are some useful financial metrics that can warn us when a business is potentially in trouble. When we see a declining return on capital employed (ROCE) in conjunction with a declining base of capital employed, that’s often how a mature business shows signs of aging. Trends like this ultimately mean the business is reducing its investments and also earning less on what it has invested. In light of that, from a first glance at Lear (NYSE:LEA), we’ve spotted some signs that it could be struggling, so let’s investigate.
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. The formula for this calculation on Lear is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.12 = US$1.0b ÷ (US$15b – US$5.8b) (Based on the trailing twelve months to June 2024).
So, Lear has an ROCE of 12%. That’s a relatively normal return on capital, and it’s around the 11% generated by the Auto Components industry.
See our latest analysis for Lear
In the above chart we have measured Lear’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 analyst report for Lear .
So How Is Lear’s ROCE Trending?
We are a bit worried about the trend of returns on capital at Lear. About five years ago, returns on capital were 18%, however they’re now substantially lower than that as we saw above. Meanwhile, capital employed in the business has stayed roughly the flat over the period. 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 Lear becoming one if things continue as they have.
In Conclusion…
All in all, the lower returns from the same amount of capital employed aren’t exactly signs of a compounding machine. In spite of that, the stock has delivered a 12% return to shareholders who held over the last five years. Either way, we aren’t huge fans of the current trends and so with that we think you might find better investments elsewhere.
Like most companies, Lear does come with some risks, and we’ve found 1 warning sign that you should be aware of.
While Lear isn’t earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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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.