Slowing Rates Of Return At Johnson Matthey (LON:JMAT) Leave Little Room For Excitement

To find a multi-bagger stock, what are the underlying trends we should look for in a business? One common approach is to try and find a company with returns on capital employed (ROCE) that are increasing, in conjunction with a growing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. However, after investigating Johnson Matthey (LON:JMAT), we don't think it's current trends fit the mold of a multi-bagger.

Understanding Return On Capital Employed (ROCE)

Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for Johnson Matthey, this is the formula:

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

0.15 = UK£516m ÷ (UK£6.7b - UK£3.2b) (Based on the trailing twelve months to March 2022).

Therefore, Johnson Matthey has an ROCE of 15%. In absolute terms, that's a satisfactory return, but compared to the Chemicals industry average of 12% it's much better.

Check out our latest analysis for Johnson Matthey

In the above chart we have measured Johnson Matthey's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering Johnson Matthey here for free.

What The Trend Of ROCE Can Tell Us

Over the past five years, Johnson Matthey's ROCE and capital employed have both remained mostly flat. Businesses with these traits tend to be mature and steady operations because they're past the growth phase. So unless we see a substantial change at Johnson Matthey 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 Johnson Matthey is paying out 39% of its income to shareholders in the form of dividends. Given the business isn't reinvesting in itself, it makes sense to distribute a portion of earnings among shareholders.

Another point to note, we noticed the company has increased current liabilities over the last five years. This is intriguing because if current liabilities hadn't increased to 47% of total assets, this reported ROCE would probably be less than15% because total capital employed would be higher.The 15% ROCE could be even lower if current liabilities weren't 47% of total assets, because the the formula would show a larger base of total capital employed. So with current liabilities at such high levels, this effectively means the likes of suppliers or short-term creditors are funding a meaningful part of the business, which in some instances can bring some risks.

What We Can Learn From Johnson Matthey's ROCE

We can conclude that in regards to Johnson Matthey's returns on capital employed and the trends, there isn't much change to report on. And investors appear hesitant that the trends will pick up because the stock has fallen 30% in the last five years. On the whole, we aren't too inspired by the underlying trends and we think there may be better chances of finding a multi-bagger elsewhere.

If you'd like to know more about Johnson Matthey, we've spotted 3 warning signs, and 1 of them shouldn't be ignored.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.