Did you know there are some financial metrics that can provide clues of a potential multi-bagger? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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. That's why when we briefly looked at Metcash's (ASX:MTS) ROCE trend, we were pretty happy with what we saw.
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. To calculate this metric for Metcash, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = AU$450m ÷ (AU$5.5b - AU$2.8b) (Based on the trailing twelve months to October 2022).
Therefore, Metcash has an ROCE of 17%. That's a relatively normal return on capital, and it's around the 16% generated by the Consumer Retailing industry.
See our latest analysis for Metcash
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 to see what analysts are forecasting going forward, you should check out our free report for Metcash.
SWOT Analysis for Metcash
- Debt is not viewed as a risk.
- Earnings declined over the past year.
- Dividend is low compared to the top 25% of dividend payers in the Consumer Retailing market.
- Annual earnings are forecast to grow for the next 4 years.
- Good value based on P/E ratio and estimated fair value.
- Significant insider buying over the past 3 months.
- Dividends are not covered by cash flow.
- Annual earnings are forecast to grow slower than the Australian market.
What The Trend Of ROCE Can Tell Us
While the current returns on capital are decent, they haven't changed much. The company has consistently earned 17% for the last five years, and the capital employed within the business has risen 38% in that time. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
Another thing to note, Metcash has a high ratio of current liabilities to total assets of 51%. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.
The Key Takeaway
To sum it up, Metcash has simply been reinvesting capital steadily, at those decent rates of return. Therefore it's no surprise that shareholders have earned a respectable 69% return if they held over the last five years. So while investors seem to be recognizing these promising trends, we still believe the stock deserves further research.
If you want to continue researching Metcash, you might be interested to know about the 1 warning sign that our analysis has discovered.
While Metcash may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
About ASX:MTS
Metcash
Operates as a wholesale distribution and marketing company in Australia.
Very undervalued with excellent balance sheet.
