Capital allocation trends at Lookers (LON: LOOK) are not ideal

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What trends should we look for if we are to identify stocks that can multiply in value over the long term? First, we will want to see a return on capital employed (ROCE) which increases and, on the other hand, a based capital employed. Ultimately, this demonstrates that this is a company that is reinvesting its profits at increasing rates of return. That said, from the first glance at The viewers (LON: LOOK) we’re not jumping from our chairs on the yield trend, but taking a closer look.

What is Return on Employee Capital (ROCE)?

For those who don’t know, ROCE is a measure of a company’s annual pre-tax profit (its return), relative to the capital employed in the company. To calculate this metric for Lookers, here is the formula:

Return on capital employed = Profit before interest and taxes (EBIT) ÷ (Total assets – Current liabilities)

0.043 = £ 31million (£ 1.8bn – £ 1.0bn) (Based on the last twelve months up to December 2020).

Therefore, Lookers has a ROCE of 4.3%. In absolute terms, that’s a low return and it’s also below the specialty retail industry average by 10%.

Check out our latest analysis for Lookers

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Above you can see how Lookers’ current ROCE compares to its previous returns on capital, but there is little you can say about the past. If you are interested, you can view analyst forecasts in our free analyst forecast report for the company.

What is the trend for returns?

In terms of Lookers’ historic ROCE movements, the trend is not great. Over the past five years, return on capital has declined to 4.3%, down from 13% five years ago. Considering the company is employing more capital while revenues have declined, this is a bit of a concern. If this were to continue, you might consider a business that is trying to reinvest for growth, but is actually losing market share since sales haven’t increased.

On a separate but related note, it’s important to know that Lookers has a current liabilities to total assets ratio of 59%, which we consider to be quite high. This can lead to certain risks as the business is essentially operating with quite a lot of dependence on its suppliers or other types of short-term creditors. Ideally, we would like this to decrease as that would mean less risky bonds.

The key to take away

We’re a little worried about Lookers, because despite deploying more capital in the business, both return on that capital and sales have fallen. So it’s no surprise that the stock has fallen 18% over the past five years, so it looks like investors are recognizing these changes. That being the case, unless the underlying trends return to a more positive trajectory, we would consider looking elsewhere.

If you’re interested in knowing the risks Lookers faces, we’ve found out 1 warning sign that you should be aware of.

While Lookers does not currently generate the highest returns, we have compiled a list of companies that currently generate over 25% return on equity. Check it out free list here.

This Simply Wall St article is general in nature. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative material. Simply Wall St has no position in any of the stocks mentioned.

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