Morgan Advanced Materials (LON:MGAM) Has More To Do To Multiply In Value Going Forward

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Amongst other things, we'll want to see two things; firstly, a growing return on capital employed (ROCE) and secondly, an expansion in the company's amount of capital employed. Ultimately, this demonstrates that it's a business that is reinvesting profits at increasing rates of return. However, after briefly looking over the numbers, we don't think Morgan Advanced Materials (LON:MGAM) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What Is 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. The formula for this calculation on Morgan Advanced Materials is:

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

0.18 = UK£133m ÷ (UK£998m - UK£251m) (Based on the trailing twelve months to June 2022).

Therefore, Morgan Advanced Materials has an ROCE of 18%. On its own, that's a standard return, however it's much better than the 11% generated by the Machinery industry.

Our analysis indicates that MGAM is potentially undervalued!

In the above chart we have measured Morgan Advanced Materials' prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

How Are Returns Trending?

Over the past five years, Morgan Advanced Materials' ROCE and capital employed have both remained mostly flat. It's not uncommon to see this when looking at a mature and stable business that isn't re-investing its earnings because it has likely passed that phase of the business cycle. So unless we see a substantial change at Morgan Advanced Materials in terms of ROCE and additional investments being made, we wouldn't hold our breath on it being a multi-bagger. This probably explains why Morgan Advanced Materials is paying out 37% of its income to shareholders in the form of dividends. Unless businesses have highly compelling growth opportunities, they'll typically return some money to shareholders.

What We Can Learn From Morgan Advanced Materials' ROCE

In summary, Morgan Advanced Materials isn't compounding its earnings but is generating stable returns on the same amount of capital employed. And investors may be recognizing these trends since the stock has only returned a total of 1.5% to shareholders over the last five years. As a result, if you're hunting for a multi-bagger, we think you'd have more luck elsewhere.

One more thing to note, we've identified 1 warning sign with Morgan Advanced Materials and understanding this should be part of your investment process.

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.