Finding a business that has the potential to grow substantially is not easy, but it is possible if we look at a few key financial metrics. Firstly, we'll want to see a proven return on capital employed (ROCE) that is increasing, and secondly, an expanding base of capital employed. This shows us that it's a compounding machine, able to continually reinvest its earnings back into the business and generate higher returns. Speaking of which, we noticed some great changes in Rio Tinto Group's (LON:RIO) returns on capital, so let's have a look.
Return On Capital Employed (ROCE): What is it?
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 Rio Tinto Group is:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.20 = US$17b ÷ (US$97b - US$12b) (Based on the trailing twelve months to December 2020).
Thus, Rio Tinto Group has an ROCE of 20%. In absolute terms, that's a satisfactory return, but compared to the Metals and Mining industry average of 14% it's much better.
Above you can see how the current ROCE for Rio Tinto Group compares to its prior returns on capital, but there's only so much you can tell from the past. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.
How Are Returns Trending?
Rio Tinto 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 294% over the last five years. So it's likely that the business is now reaping the full benefits of its past investments, since the capital employed hasn't changed considerably. On that front, things are looking good so it's worth exploring what management has said about growth plans going forward.
Our Take On Rio Tinto Group's ROCE
As discussed above, Rio Tinto Group appears to be getting more proficient at generating returns since capital employed has remained flat but earnings (before interest and tax) are up. 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.
One final note, you should learn about the 3 warning signs we've spotted with Rio Tinto Group (including 1 which is potentially serious) .
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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