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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. So on that note, Metcash (ASX:MTS) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Metcash, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.15 = AU$383m ÷ (AU$5.1b - AU$2.6b) (Based on the trailing twelve months to October 2021).
So, Metcash has an ROCE of 15%. In absolute terms, that's a pretty normal return, and it's somewhat close to the Consumer Retailing industry average of 14%.
Above you can see how the current ROCE for Metcash compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Metcash here for free.
What Does the ROCE Trend For Metcash Tell Us?
Metcash is displaying some positive trends. The data shows that returns on capital have increased substantially over the last five years to 15%. The company is effectively making more money per dollar of capital used, and it's worth noting that the amount of capital has increased too, by 30%. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.
Another thing to note, Metcash has a high ratio of current liabilities to total assets of 52%. 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.
What We Can Learn From Metcash's ROCE
To sum it up, Metcash has proven it can reinvest in the business and generate higher returns on that capital employed, which is terrific. Since the stock has returned a staggering 190% to shareholders over the last five years, it looks like investors are recognizing these changes. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.
Metcash does have some risks though, and we've spotted 1 warning sign for Metcash that you might be interested in.
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.