If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. In light of that, when we looked at Iberpapel Gestión (BME:IBG) and its ROCE trend, we weren't exactly thrilled.
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. Analysts use this formula to calculate it for Iberpapel Gestión:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.0046 = €1.6m ÷ (€385m - €35m) (Based on the trailing twelve months to September 2020).
Therefore, Iberpapel Gestión has an ROCE of 0.5%. Ultimately, that's a low return and it under-performs the Forestry industry average of 6.5%.
In the above chart we have measured Iberpapel Gestión'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 Iberpapel Gestión here for free.
What Can We Tell From Iberpapel Gestión's ROCE Trend?
In terms of Iberpapel Gestión's historical ROCE movements, the trend isn't fantastic. Over the last five years, returns on capital have decreased to 0.5% from 5.6% five years ago. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.
What We Can Learn From Iberpapel Gestión's ROCE
We're a bit apprehensive about Iberpapel Gestión because despite more capital being deployed in the business, returns on that capital and sales have both fallen. Investors must expect better things on the horizon though because the stock has risen 13% in the last five years. Regardless, we don't like the trends as they are and if they persist, we think you might find better investments elsewhere.
One more thing to note, we've identified 2 warning signs with Iberpapel Gestión and understanding these should be part of your investment process.
While Iberpapel Gestión isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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This article by Simply Wall St is general in nature. 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.
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