What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base 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. So on that note, Penske Automotive Group (NYSE:PAG) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
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 Penske Automotive Group, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.14 = US$1.4b ÷ (US$16b - US$5.7b) (Based on the trailing twelve months to December 2023).
Therefore, Penske Automotive Group has an ROCE of 14%. That's a relatively normal return on capital, and it's around the 13% generated by the Specialty Retail industry.
Above you can see how the current ROCE for Penske Automotive Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Penske Automotive Group.
What Can We Tell From Penske Automotive Group's ROCE Trend?
We like the trends that we're seeing from Penske Automotive Group. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 14%. The amount of capital employed has increased too, by 71%. So we're very much inspired by what we're seeing at Penske Automotive Group thanks to its ability to profitably reinvest capital.
On a related note, the company's ratio of current liabilities to total assets has decreased to 36%, which basically reduces it's funding from the likes of short-term creditors or suppliers. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.
What We Can Learn From Penske Automotive Group's ROCE
In summary, it's great to see that Penske Automotive Group can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
If you'd like to know more about Penske Automotive Group, we've spotted 4 warning signs, and 1 of them makes us a bit uncomfortable.
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.
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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.
