What are the early trends we should look for to identify a stock that could 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. So on that note, Vallourec (EPA:VK) looks quite promising in regards to its trends of return on capital.
What is 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. The formula for this calculation on Vallourec is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.058 = €202m ÷ (€4.6b - €1.1b) (Based on the trailing twelve months to September 2021).
Thus, Vallourec has an ROCE of 5.8%. On its own that's a low return on capital but it's in line with the industry's average returns of 5.6%.
Above you can see how the current ROCE for Vallourec compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Vallourec here for free.
The Trend Of ROCE
It's great to see that Vallourec has started to generate some pre-tax earnings from prior investments. The company was generating losses five years ago, but now it's turned around, earning 5.8% which is no doubt a relief for some early shareholders. Additionally, the business is utilizing 33% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. The reduction could indicate that the company is selling some assets, and considering returns are up, they appear to be selling the right ones.
What We Can Learn From Vallourec's ROCE
In the end, Vallourec has proven it's capital allocation skills are good with those higher returns from less amount of capital. And since the stock has dived 90% over the last five years, there may be other factors affecting the company's prospects. Still, it's worth doing some further research to see if the trends will continue into the future.
If you want to know some of the risks facing Vallourec we've found 2 warning signs (1 is potentially serious!) that you should be aware of before investing here.
For those who like to invest in solid companies, check out this free list of companies with solid balance sheets and high 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.