Here's What To Make Of Orica's (ASX:ORI) Decelerating Rates Of Return

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. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. Although, when we looked at Orica (ASX:ORI), it didn't seem to tick all of these boxes.

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

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. The formula for this calculation on Orica is:

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

0.09 = AU$532m ÷ (AU$8.4b - AU$2.5b) (Based on the trailing twelve months to September 2022).

Therefore, Orica has an ROCE of 9.0%. In absolute terms, that's a low return but it's around the Chemicals industry average of 10%.

View our latest analysis for Orica

Above you can see how the current ROCE for Orica compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Orica here for free.

So How Is Orica's ROCE Trending?

Things have been pretty stable at Orica, with its capital employed and returns on that capital staying somewhat the same for the last five years. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. With that in mind, unless investment picks up again in the future, we wouldn't expect Orica to be a multi-bagger going forward. This probably explains why Orica is paying out 50% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 30% of total assets, this reported ROCE would probably be less than9.0% because total capital employed would be higher.The 9.0% ROCE could be even lower if current liabilities weren't 30% of total assets, because the the formula would show a larger base of total capital employed. With that in mind, just be wary if this ratio increases in the future, because if it gets particularly high, this brings with it some new elements of risk.

What We Can Learn From Orica's ROCE

We can conclude that in regards to Orica's returns on capital employed and the trends, there isn't much change to report on. Unsurprisingly then, the total return to shareholders over the last five years has been flat. In any case, the stock doesn't have these traits of a multi-bagger discussed above, so if that's what you're looking for, we think you'd have more luck elsewhere.

Like most companies, Orica does come with some risks, and we've found 2 warning signs that you should be aware of.

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.