Champion Iron (ASX:CIA) Knows How To Allocate Capital Effectively

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Typically, we'll want to notice a trend of growing return on capital employed (ROCE) and alongside that, an expanding base 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. And in light of that, the trends we're seeing at Champion Iron's (ASX:CIA) look very promising so lets take a look.

Return On Capital Employed (ROCE): What Is It?

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 Champion Iron is:

Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)

0.20 = CA$396m ÷ (CA$2.2b - CA$231m) (Based on the trailing twelve months to December 2022).

Therefore, Champion Iron has an ROCE of 20%. That's a fantastic return and not only that, it outpaces the average of 10% earned by companies in a similar industry.

See our latest analysis for Champion Iron

Above you can see how the current ROCE for Champion Iron 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 Champion Iron.

The Trend Of ROCE

We're delighted to see that Champion Iron is reaping rewards from its investments and is now generating some pre-tax profits. About five years ago the company was generating losses but things have turned around because it's now earning 20% on its capital. In addition to that, Champion Iron is employing 768% more capital than previously which is expected of a company that's trying to break into profitability. This can indicate that there's plenty of opportunities to invest capital internally and at ever higher rates, both common traits of a multi-bagger.

In another part of our analysis, we noticed that the company's ratio of current liabilities to total assets decreased to 11%, which broadly means the business is relying less on its suppliers or short-term creditors to fund its operations. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

The Bottom Line

Long story short, we're delighted to see that Champion Iron's reinvestment activities have paid off and the company is now profitable. Since the stock has returned a staggering 525% to shareholders over the last five years, it looks like investors are recognizing these changes. Therefore, we think it would be worth your time to check if these trends are going to continue.

Champion Iron does have some risks, we noticed 3 warning signs (and 1 which is significant) we think you should know about.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.