Fortescue (ASX:FMG) Might Become A Compounding Machine

What are the early trends we should look for to identify a stock that could multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. With that in mind, the ROCE of Fortescue (ASX:FMG) looks attractive right now, so lets see what the trend of returns can tell us.

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 Fortescue, this is the formula:

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

0.31 = US$8.5b ÷ (US$30b - US$2.7b) (Based on the trailing twelve months to June 2024).

Therefore, Fortescue has an ROCE of 31%. In absolute terms that's a great return and it's even better than the Metals and Mining industry average of 10.0%.

Check out our latest analysis for Fortescue

In the above chart we have measured Fortescue's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free analyst report for Fortescue .

So How Is Fortescue's ROCE Trending?

We'd be pretty happy with returns on capital like Fortescue. The company has consistently earned 31% for the last five years, and the capital employed within the business has risen 61% in that time. With returns that high, it's great that the business can continually reinvest its money at such appealing rates of return. If Fortescue can keep this up, we'd be very optimistic about its future.

The Bottom Line

In short, we'd argue Fortescue has the makings of a multi-bagger since its been able to compound its capital at very profitable rates of return. And the stock has done incredibly well with a 180% return over the last five years, so long term investors are no doubt ecstatic with that result. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.

One final note, you should learn about the 2 warning signs we've spotted with Fortescue (including 1 which doesn't sit too well with us) .

If you want to search for more stocks that have been earning high returns, check out this free list of stocks with solid balance sheets that are also earning 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.