What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing base 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 Mersen (EPA:MRN) and its ROCE trend, we weren't exactly thrilled.
What is Return On Capital Employed (ROCE)?
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. The formula for this calculation on Mersen is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.077 = €82m ÷ (€1.3b - €196m) (Based on the trailing twelve months to June 2020).
Therefore, Mersen has an ROCE of 7.7%. Ultimately, that's a low return and it under-performs the Electrical industry average of 11%.
Above you can see how the current ROCE for Mersen compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
So How Is Mersen's ROCE Trending?
The returns on capital haven't changed much for Mersen in recent years. The company has consistently earned 7.7% for the last five years, and the capital employed within the business has risen 26% in that time. This poor ROCE doesn't inspire confidence right now, and with the increase in capital employed, it's evident that the business isn't deploying the funds into high return investments.
The Bottom Line
In summary, Mersen has simply been reinvesting capital and generating the same low rate of return as before. Yet to long term shareholders the stock has gifted them an incredible 166% return in the last five years, so the market appears to be rosy about its future. However, unless these underlying trends turn more positive, we wouldn't get our hopes up too high.
One more thing to note, we've identified 2 warning signs with Mersen and understanding them should be part of your investment process.
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