Returns On Capital Are Showing Encouraging Signs At Chemring Group (LON:CHG)

What trends should we look for it we want to identify stocks that can multiply in value over the long term? Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. With that in mind, we've noticed some promising trends at Chemring Group (LON:CHG) so let's look a bit deeper.

Understanding Return On Capital Employed (ROCE)

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. To calculate this metric for Chemring Group, this is the formula:

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

0.11 = UK£48m ÷ (UK£541m - UK£112m) (Based on the trailing twelve months to April 2021).

Therefore, Chemring Group has an ROCE of 11%. That's a pretty standard return and it's in line with the industry average of 11%.

Check out our latest analysis for Chemring Group

In the above chart we have measured Chemring Group's prior ROCE against its prior performance, but the future is arguably more important. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Chemring Group.

What The Trend Of ROCE Can Tell Us

Chemring Group is showing promise given that its ROCE is trending up and to the right. Looking at the data, we can see that even though capital employed in the business has remained relatively flat, the ROCE generated has risen by 205% over the last five years. Basically the business is generating higher returns from the same amount of capital and that is proof that there are improvements in the company's efficiencies. The company is doing well in that sense, and it's worth investigating what the management team has planned for long term growth prospects.

The Key Takeaway

To bring it all together, Chemring Group has done well to increase the returns it's generating from its capital employed. And with the stock having performed exceptionally well over the last five years, these patterns are being accounted for by investors. So given the stock has proven it has promising trends, it's worth researching the company further to see if these trends are likely to persist.

On the other side of ROCE, we have to consider valuation. That's why we have a FREE intrinsic value estimation on our platform that is definitely worth checking out.

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. 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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