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. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Stelco Holdings (TSE:STLC) has the makings of a multi-bagger going forward, but let's have a look at why that may be.
Return On Capital Employed (ROCE): What is it?
For those that aren't sure what ROCE is, it measures the amount of pre-tax profits a company can generate from the capital employed in its business. The formula for this calculation on Stelco Holdings is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.065 = CA$74m ÷ (CA$1.8b - CA$628m) (Based on the trailing twelve months to March 2021).
So, Stelco Holdings has an ROCE of 6.5%. On its own that's a low return, but compared to the average of 2.8% generated by the Metals and Mining industry, it's much better.
In the above chart we have measured Stelco Holdings' 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 Stelco Holdings.
What Can We Tell From Stelco Holdings' ROCE Trend?
In terms of Stelco Holdings' historical ROCE movements, the trend isn't fantastic. Around three years ago the returns on capital were 17%, but since then they've fallen to 6.5%. On the other hand, the company has been employing more capital without a corresponding improvement in sales in the last year, which could suggest these investments are longer term plays. It may take some time before the company starts to see any change in earnings from these investments.
While on the subject, we noticed that the ratio of current liabilities to total assets has risen to 35%, which has impacted the ROCE. Without this increase, it's likely that ROCE would be even lower than 6.5%. While the ratio isn't currently too high, it's worth keeping an eye on this because if it gets particularly high, the business could then face some new elements of risk.
Our Take On Stelco Holdings' ROCE
To conclude, we've found that Stelco Holdings is reinvesting in the business, but returns have been falling. Since the stock has gained an impressive 75% over the last three years, investors must think there's better things to come. But if the trajectory of these underlying trends continue, we think the likelihood of it being a multi-bagger from here isn't high.
Stelco Holdings does come with some risks though, we found 3 warning signs in our investment analysis, and 2 of those are a bit unpleasant...
If you want to search for solid companies with great earnings, check out this free list of companies with good balance sheets and impressive returns on equity.
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