What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. So on that note, Incitec Pivot (ASX:IPL) looks quite promising in regards to its trends of return on capital.
Understanding Return On Capital Employed (ROCE)
If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Incitec Pivot:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.064 = AU$500m ÷ (AU$9.4b - AU$1.5b) (Based on the trailing twelve months to September 2021).
So, Incitec Pivot has an ROCE of 6.4%. In absolute terms, that's a low return but it's around the Chemicals industry average of 5.4%.
In the above chart we have measured Incitec Pivot'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 report for Incitec Pivot.
What The Trend Of ROCE Can Tell Us
Incitec Pivot has not disappointed with their ROCE growth. The figures show that over the last five years, ROCE has grown 32% whilst employing roughly the same amount of capital. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. It's worth looking deeper into this though because while it's great that the business is more efficient, it might also mean that going forward the areas to invest internally for the organic growth are lacking.
The Bottom Line
To sum it up, Incitec Pivot is collecting higher returns from the same amount of capital, and that's impressive. Investors may not be impressed by the favorable underlying trends yet because over the last five years the stock has only returned 0.6% to shareholders. Given that, we'd look further into this stock in case it has more traits that could make it multiply in the long term.
One more thing to note, we've identified 2 warning signs with Incitec Pivot and understanding these should be part of your investment process.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and 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.