If you're looking at a mature business that's past the growth phase, what are some of the underlying trends that pop up? Businesses in decline often have two underlying trends, firstly, a declining return on capital employed (ROCE) and a declining base of capital employed. Basically the company is earning less on its investments and it is also reducing its total assets. So after we looked into Advance Auto Parts (NYSE:AAP), the trends above didn't look too great.

What Is 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. The formula for this calculation on Advance Auto Parts is:

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

0.02 = US$140m ÷ (US$12b - US$5.6b) (Based on the trailing twelve months to October 2024).

Thus, Advance Auto Parts has an ROCE of 2.0%. In absolute terms, that's a low return and it also under-performs the Specialty Retail industry average of 13%.

In the above chart we have measured Advance Auto Parts' 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 analyst report for Advance Auto Parts .

How Are Returns Trending?

In terms of Advance Auto Parts' historical ROCE movements, the trend doesn't inspire confidence. To be more specific, the ROCE was 11% five years ago, but since then it has dropped noticeably. Meanwhile, capital employed in the business has stayed roughly the flat over the period. Companies that exhibit these attributes tend to not be shrinking, but they can be mature and facing pressure on their margins from competition. If these trends continue, we wouldn't expect Advance Auto Parts to turn into a multi-bagger.

On a separate but related note, it's important to know that Advance Auto Parts has a current liabilities to total assets ratio of 45%, which we'd consider pretty high. This can bring about some risks because the company is basically operating with a rather large reliance on its suppliers or other sorts of short-term creditors. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

In Conclusion...

In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Investors haven't taken kindly to these developments, since the stock has declined 70% from where it was five years ago. Unless there is a shift to a more positive trajectory in these metrics, we would look elsewhere.

Advance Auto Parts does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those is a bit concerning...

While Advance Auto Parts isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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.