Capital Allocation Trends At FLSmidth (CPH:FLS) Aren't Ideal

If you're looking for a multi-bagger, there's a few things to keep an eye out for. One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. Having said that, from a first glance at FLSmidth (CPH:FLS) we aren't jumping out of our chairs at how returns are trending, but let's have a deeper look.

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

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 FLSmidth, this is the formula:

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

0.072 = kr.1.1b ÷ (kr.29b - kr.13b) (Based on the trailing twelve months to September 2023).

Thus, FLSmidth has an ROCE of 7.2%. In absolute terms, that's a low return and it also under-performs the Machinery industry average of 12%.

Check out our latest analysis for FLSmidth

In the above chart we have measured FLSmidth's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering FLSmidth here for free.

What The Trend Of ROCE Can Tell Us

The trend of ROCE doesn't look fantastic because it's fallen from 10% five years ago, while the business's capital employed increased by 43%. However, some of the increase in capital employed could be attributed to the recent capital raising that's been completed prior to their latest reporting period, so keep that in mind when looking at the ROCE decrease. FLSmidth probably hasn't received a full year of earnings yet from the new funds it raised, so these figures should be taken with a grain of salt.

On a side note, FLSmidth's current liabilities are still rather high at 46% of total assets. This effectively means that suppliers (or short-term creditors) are funding a large portion of the business, so just be aware that this can introduce some elements of risk. While it's not necessarily a bad thing, it can be beneficial if this ratio is lower.

The Bottom Line On FLSmidth's ROCE

In summary, despite lower returns in the short term, we're encouraged to see that FLSmidth is reinvesting for growth and has higher sales as a result. These trends are starting to be recognized by investors since the stock has delivered a 5.9% gain to shareholders who've held over the last five years. Therefore we'd recommend looking further into this stock to confirm if it has the makings of a good investment.

If you want to continue researching FLSmidth, you might be interested to know about the 2 warning signs that our analysis has discovered.

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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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.