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. That's why when we briefly looked at Mahindra & Mahindra's (NSE:M&M) ROCE trend, we were pretty happy with what we saw.
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. To calculate this metric for Mahindra & Mahindra, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.10 = ₹116b ÷ (₹1.7t - ₹528b) (Based on the trailing twelve months to December 2021).
Therefore, Mahindra & Mahindra has an ROCE of 10%. In absolute terms, that's a pretty standard return but compared to the Auto industry average it falls behind.
Above you can see how the current ROCE for Mahindra & Mahindra compares to its prior returns on capital, but there's only so much you can tell from the past. If you'd like, you can check out the forecasts from the analysts covering Mahindra & Mahindra here for free.
The Trend Of ROCE
While the current returns on capital are decent, they haven't changed much. The company has employed 63% more capital in the last five years, and the returns on that capital have remained stable at 10%. Since 10% 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.
To sum it up, Mahindra & Mahindra has simply been reinvesting capital steadily, at those decent rates of return. And since the stock has risen strongly over the last five years, it appears the market might expect this trend to continue. So while the positive underlying trends may be accounted for by investors, we still think this stock is worth looking into further.
Mahindra & Mahindra does come with some risks though, we found 3 warning signs in our investment analysis, and 1 of those can't be ignored...
While Mahindra & Mahindra isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.
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.