What trends should we look for it we want to identify stocks that can multiply in value over the long term? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Visteon's (NASDAQ:VC) returns on capital, so let's have a look.
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. The formula for this calculation on Visteon is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.059 = US$81m ÷ (US$2.2b - US$788m) (Based on the trailing twelve months to September 2020).
So, Visteon has an ROCE of 5.9%. Ultimately, that's a low return and it under-performs the Auto Components industry average of 10%.
View our latest analysis for Visteon
Above you can see how the current ROCE for Visteon compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
The Trend Of ROCE
You'd find it hard not to be impressed with the ROCE trend at Visteon. We found that the returns on capital employed over the last five years have risen by 60%. The company is now earning US$0.06 per dollar of capital employed. Speaking of capital employed, the company is actually utilizing 64% less than it was five years ago, which can be indicative of a business that's improving its efficiency. If this trend continues, the business might be getting more efficient but it's shrinking in terms of total assets.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 36% of its operations, which isn't ideal. Keep an eye out for future increases because when the ratio of current liabilities to total assets gets particularly high, this can introduce some new risks for the business.
What We Can Learn From Visteon's ROCE
From what we've seen above, Visteon has managed to increase it's returns on capital all the while reducing it's capital base. Since the stock has only returned 37% to shareholders over the last five years, the promising fundamentals may not be recognized yet by investors. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
On a final note, we found 2 warning signs for Visteon (1 shouldn't be ignored) you should be aware of.
While Visteon isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
This article by Simply Wall St is general in nature. 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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