NKT (CPH:NKT) Is Looking To Continue Growing Its Returns On Capital

What trends should we look for it we want to identify stocks that can multiply in value over the long term? 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. If you see this, it typically means it's a company with a great business model and plenty of profitable reinvestment opportunities. With that in mind, we've noticed some promising trends at NKT (CPH:NKT) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

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. To calculate this metric for NKT, this is the formula:

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

0.074 = €101m ÷ (€3.1b - €1.7b) (Based on the trailing twelve months to June 2023).

So, NKT has an ROCE of 7.4%. In absolute terms, that's a low return and it also under-performs the Electrical industry average of 13%.

View our latest analysis for NKT

In the above chart we have measured NKT'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 NKT here for free.

What Does the ROCE Trend For NKT Tell Us?

Shareholders will be relieved that NKT has broken into profitability. The company was generating losses five years ago, but has managed to turn it around and as we saw earlier is now earning 7.4%, which is always encouraging. On top of that, what's interesting is that the amount of capital being employed has remained steady, so the business hasn't needed to put any additional money to work to generate these higher returns. So while we're happy that the business is more efficient, just keep in mind that could mean that going forward the business is lacking areas to invest internally for growth. After all, a company can only become a long term multi-bagger if it continually reinvests in itself at high rates of return.

On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. Essentially the business now has suppliers or short-term creditors funding about 56% of its operations, which isn't ideal. And with current liabilities at those levels, that's pretty high.

The Bottom Line

To sum it up, NKT is collecting higher returns from the same amount of capital, and that's impressive. Since the stock has returned a staggering 202% to shareholders over the last five years, it looks like investors are recognizing these changes. In light of that, we think it's worth looking further into this stock because if NKT can keep these trends up, it could have a bright future ahead.

If you'd like to know about the risks facing NKT, we've discovered 1 warning sign that you should be aware of.

While NKT may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list 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.