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Be Wary Of Lear (NYSE:LEA) And Its Returns On Capital

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Did you know there are some financial metrics that can provide clues of a potential 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. However, after investigating Lear (NYSE:LEA), we don't think it's current trends fit the mold of a multi-bagger.

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. To calculate this metric for Lear, this is the formula:

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

0.14 = US$1.1b ÷ (US$13b - US$5.0b) (Based on the trailing twelve months to October 2021).

Thus, Lear has an ROCE of 14%. In absolute terms, that's a satisfactory return, but compared to the Auto Components industry average of 9.5% it's much better.

View our latest analysis for Lear

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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 report for Lear.

The Trend Of ROCE

In terms of Lear's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 14% from 26% five years ago. However, given capital employed and revenue have both increased it appears that the business is currently pursuing growth, at the consequence of short term returns. And if the increased capital generates additional returns, the business, and thus shareholders, will benefit in the long run.

The Bottom Line

In summary, despite lower returns in the short term, we're encouraged to see that Lear is reinvesting for growth and has higher sales as a result. Furthermore the stock has climbed 44% over the last five years, it would appear that investors are upbeat about the future. So while the underlying trends could already be accounted for by investors, we still think this stock is worth looking into further.

If you'd like to know about the risks facing Lear, we've discovered 2 warning signs that you should be aware of.

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.

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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