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Capital Allocation Trends At Lear (NYSE:LEA) Aren't Ideal

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If you're looking for a multi-bagger, there's a few things to keep an eye out for. Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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 Lear (NYSE:LEA) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

What is 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 Lear is:

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

0.076 = US$655m ÷ (US$14b - US$5.1b) (Based on the trailing twelve months to April 2022).

So, Lear has an ROCE of 7.6%. In absolute terms, that's a low return but it's around the Auto Components industry average of 9.0%.

View our latest analysis for Lear

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roce

In the above chart we have measured Lear'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.

How Are Returns Trending?

In terms of Lear's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 25%, but since then they've fallen to 7.6%. Meanwhile, the business is utilizing more capital but this hasn't moved the needle much in terms of sales in the past 12 months, so this could reflect longer term investments. It's worth keeping an eye on the company's earnings from here on to see if these investments do end up contributing to the bottom line.

What We Can Learn From Lear's ROCE

Bringing it all together, while we're somewhat encouraged by Lear's reinvestment in its own business, we're aware that returns are shrinking. Unsurprisingly, the stock has only gained 4.2% over the last five years, which potentially indicates that investors are accounting for this going forward. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

Like most companies, Lear does come with some risks, and we've found 3 warning signs that you should be aware of.

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.

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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