What are the early trends we should look for to identify a stock that could multiply in value over the long term? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount 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, the ROCE of Johnson Matthey (LON:JMAT) looks decent, right now, so lets see what the trend of returns can tell us.
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. The formula for this calculation on Johnson Matthey is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.17 = UK£654m ÷ (UK£7.5b - UK£3.6b) (Based on the trailing twelve months to September 2021).
Therefore, Johnson Matthey has an ROCE of 17%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 11% it's much better.
Check out our latest analysis for Johnson Matthey
Above you can see how the current ROCE for Johnson Matthey compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like to see what analysts are forecasting going forward, you should check out our free report for Johnson Matthey.
The Trend Of ROCE
While the returns on capital are good, they haven't moved much. The company has consistently earned 17% for the last five years, and the capital employed within the business has risen 27% in that time. Since 17% is a moderate ROCE though, it's good to see a business can continue to reinvest at these decent rates of return. Over long periods of time, returns like these might not be too exciting, but with consistency they can pay off in terms of share price returns.
On another note, while the change in ROCE trend might not scream for attention, it's interesting that the current liabilities have actually gone up over the last five years. This is intriguing because if current liabilities hadn't increased to 48% of total assets, this reported ROCE would probably be less than17% because total capital employed would be higher.The 17% ROCE could be even lower if current liabilities weren't 48% of total assets, because the the formula would show a larger base of total capital employed. Additionally, this high level of current liabilities isn't ideal because it means the company's suppliers (or short-term creditors) are effectively funding a large portion of the business.
What We Can Learn From Johnson Matthey's ROCE
To sum it up, Johnson Matthey has simply been reinvesting capital steadily, at those decent rates of return. Yet over the last five years the stock has declined 26%, so the decline might provide an opening. That's why we think it'd be worthwhile to look further into this stock given the fundamentals are appealing.
On a final note, we've found 2 warning signs for Johnson Matthey that we think you should be aware of.
While Johnson Matthey may not currently earn the highest returns, we've compiled a list of companies that currently earn more than 25% return on equity. Check out this free list here.
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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.
About LSE:JMAT
Johnson Matthey
Engages in the clean air, catalyst and hydrogen technology, and platinum group metals (PGM) service businesses in the United Kingdom, Germany, rest of Europe, the United States, rest of North America, China, rest of Asia, and internationally.
Undervalued with solid track record.
