Yahoo Finance CarGurus (NASDAQ:CARG) Will Be Hoping To Turn Its Returns On Capital Around
There are a few key trends to look for if we want to identify the next multi-bagger. Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Having said that, from a first glance at CarGurus (NASDAQ:CARG) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.
Return On Capital Employed (ROCE): What Is It?
For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. To calculate this metric for CarGurus, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.16 = US$136m ÷ (US$1.0b - US$176m) (Based on the trailing twelve months to June 2022).
Therefore, CarGurus has an ROCE of 16%. In absolute terms, that's a satisfactory return, but compared to the Interactive Media and Services industry average of 4.5% it's much better.
View our latest analysis for CarGurus
In the above chart we have measured CarGurus' 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 CarGurus.
What Can We Tell From CarGurus' ROCE Trend?
Unfortunately, the trend isn't great with ROCE falling from 25% five years ago, while capital employed has grown 925%. Usually this isn't ideal, but given CarGurus conducted a capital raising before their most recent earnings announcement, that would've likely contributed, at least partially, to the increased capital employed figure. The funds raised likely haven't been put to work yet so it's worth watching what happens in the future with CarGurus' earnings and if they change as a result from the capital raise. Additionally, we found that CarGurus' most recent EBIT figure is around the same as the prior year, so we'd attribute the drop in ROCE mostly to the capital raise.
On a related note, CarGurus has decreased its current liabilities to 17% of total assets. So we could link some of this to the decrease in ROCE. What's more, this can reduce some aspects of risk to the business because now the company's suppliers or short-term creditors are funding less of its operations. Since the business is basically funding more of its operations with it's own money, you could argue this has made the business less efficient at generating ROCE.
What We Can Learn From CarGurus' ROCE
In summary, despite lower returns in the short term, we're encouraged to see that CarGurus is reinvesting for growth and has higher sales as a result. However, despite the promising trends, the stock has fallen 50% over the last five years, so there might be an opportunity here for astute investors. As a result, we'd recommend researching this stock further to uncover what other fundamentals of the business can show us.
While CarGurus doesn't shine too bright in this respect, it's still worth seeing if the company is trading at attractive prices. You can find that out with our FREE intrinsic value estimation on our platform.
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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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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