The Returns On Capital At Fortescue (ASX:FMG) Don't Inspire Confidence

Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's 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. Having said that, while the ROCE is currently high for Fortescue (ASX:FMG), we aren't jumping out of our chairs because returns are decreasing.

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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. Analysts use this formula to calculate it for Fortescue:

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

0.22 = US$5.9b ÷ (US$29b - US$2.2b) (Based on the trailing twelve months to December 2024).

Therefore, Fortescue has an ROCE of 22%. That's a fantastic return and not only that, it outpaces the average of 8.3% earned by companies in a similar industry.

View our latest analysis for Fortescue

Above you can see how the current ROCE for Fortescue compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free analyst report for Fortescue .

What Does the ROCE Trend For Fortescue Tell Us?

In terms of Fortescue's historical ROCE movements, the trend isn't fantastic. While it's comforting that the ROCE is high, five years ago it was 38%. And considering revenue has dropped while employing more capital, we'd be cautious. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

What We Can Learn From Fortescue's ROCE

In summary, we're somewhat concerned by Fortescue's diminishing returns on increasing amounts of capital. Yet despite these poor fundamentals, the stock has gained a huge 120% over the last five years, so investors appear very optimistic. Regardless, we don't feel too comfortable with the fundamentals so we'd be steering clear of this stock for now.

If you'd like to know more about Fortescue, we've spotted 2 warning signs, and 1 of them is concerning.

If you'd like to see other companies earning high returns, check out our free list of companies earning high returns with solid balance sheets 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.