If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? In a perfect world, we'd like to see a company investing more capital into its business and ideally the returns earned from that capital are also increasing. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at BlueScope Steel (ASX:BSL) so let's look a bit deeper.
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. The formula for this calculation on BlueScope Steel is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.083 = AU$738m ÷ (AU$11b - AU$2.4b) (Based on the trailing twelve months to December 2020).
Therefore, BlueScope Steel has an ROCE of 8.3%. On its own, that's a low figure but it's around the 8.9% average generated by the Metals and Mining industry.
In the above chart we have measured BlueScope Steel's 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 report on analyst forecasts for the company.
What Can We Tell From BlueScope Steel's ROCE Trend?
Even though ROCE is still low in absolute terms, it's good to see it's heading in the right direction. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 8.3%. The amount of capital employed has increased too, by 36%. So we're very much inspired by what we're seeing at BlueScope Steel thanks to its ability to profitably reinvest capital.
In summary, it's great to see that BlueScope Steel can compound returns by consistently reinvesting capital at increasing rates of return, because these are some of the key ingredients of those highly sought after multi-baggers. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. With that being said, we still think the promising fundamentals mean the company deserves some further due diligence.
One more thing: We've identified 4 warning signs with BlueScope Steel (at least 1 which is potentially serious) , and understanding them would certainly be useful.
While BlueScope Steel isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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