If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we’ll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company’s amount of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. In light of that, when we looked at Intrepid Potash (NYSE:IPI) and its ROCE trend, we weren’t exactly thrilled.
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 Intrepid Potash, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets – Current Liabilities)
0.021 = US$11m ÷ (US$598m – US$83m) (Based on the trailing twelve months to March 2020).
So, Intrepid Potash has an ROCE of 2.1%. Ultimately, that’s a low return and it under-performs the Chemicals industry average of 9.7%.
Above you can see how the current ROCE for Intrepid Potash 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.
So How Is Intrepid Potash’s ROCE Trending?
Over the past five years, Intrepid Potash’s ROCE has remained relatively flat while the business is using 54% less capital than before. When a company effectively decreases its assets base, it’s not usually a sign to be optimistic on that company. Not only that, but the low returns on this capital mentioned earlier would leave most investors unimpressed.On another note, while the change in ROCE trend might not scream for attention, it’s interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn’t increased to 14% of total assets, this reported ROCE would probably be less than2.1% because total capital employed would be higher.The 2.1% ROCE could be even lower if current liabilities weren’t 14% of total assets, because the the formula would show a larger base of total capital employed. So while current liabilities isn’t high right now, keep an eye out in case it increases further, because this can introduce some elements of risk.
Our Take On Intrepid Potash’s ROCE
In summary, Intrepid Potash isn’t reinvesting funds back into the business and returns aren’t growing. It seems that investors have little hope of these trends getting any better and that may have partly contributed to the stock collapsing 89% in the last five years. Therefore based on the analysis done in this article, we don’t think Intrepid Potash has the makings of a multi-bagger.
On a final note, we’ve found 3 warning signs for Intrepid Potash that we think 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.
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