These Return Metrics Don't Make Inchcape (LON:INCH) Look Too Strong
Ignoring the stock price of a company, what are the underlying trends that tell us a business is past the growth phase? More often than not, we'll see a declining return on capital employed (ROCE) and a declining amount of capital employed. This reveals that the company isn't compounding shareholder wealth because returns are falling and its net asset base is shrinking. So after glancing at the trends within Inchcape (LON:INCH), we weren't too hopeful.
Understanding Return On Capital Employed (ROCE)
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. Analysts use this formula to calculate it for Inchcape:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.091 = UK£166m ÷ (UK£3.6b - UK£1.8b) (Based on the trailing twelve months to December 2020).
Thus, Inchcape has an ROCE of 9.1%. Ultimately, that's a low return and it under-performs the Retail Distributors industry average of 15%.
See our latest analysis for Inchcape
In the above chart we have measured Inchcape's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Inchcape here for free.
What Does the ROCE Trend For Inchcape Tell Us?
We are a bit worried about the trend of returns on capital at Inchcape. To be more specific, the ROCE was 20% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Since returns are falling and the business has the same amount of assets employed, this can suggest it's a mature business that hasn't had much growth in the last five years. So because these trends aren't typically conducive to creating a multi-bagger, we wouldn't hold our breath on Inchcape becoming one if things continue as they have.
On a separate but related note, it's important to know that Inchcape has a current liabilities to total assets ratio of 50%, 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. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
Our Take On Inchcape's ROCE
In summary, it's unfortunate that Inchcape is generating lower returns from the same amount of capital. Despite the concerning underlying trends, the stock has actually gained 38% over the last five years, so it might be that the investors are expecting the trends to reverse. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
One more thing to note, we've identified 1 warning sign with Inchcape and understanding this should be part of your investment process.
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.
This article by Simply Wall St is general in nature. 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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