If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? 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. Put simply, these types of businesses are compounding machines, meaning they are continually reinvesting their earnings at ever-higher rates of return. Speaking of which, we noticed some great changes in MSP Steel & Power's (NSE:MSPL) 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. To calculate this metric for MSP Steel & Power, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.024 = ₹283m ÷ (₹17b - ₹5.8b) (Based on the trailing twelve months to March 2020).
So, MSP Steel & Power has an ROCE of 2.4%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 12%.
Check out our latest analysis for MSP Steel & Power
While the past is not representative of the future, it can be helpful to know how a company has performed historically, which is why we have this chart above. If you're interested in investigating MSP Steel & Power's past further, check out this free graph of past earnings, revenue and cash flow.
The Trend Of ROCE
We're delighted to see that MSP Steel & Power is reaping rewards from its investments and has now broken into profitability. Historically the company was generating losses but as we can see from the latest figures referenced above, they're now earning 2.4% on their capital employed. Additionally, the business is utilizing 26% less capital than it was five years ago, and taken at face value, that can mean the company needs less funds at work to get a return. This could potentially mean that the company is selling some of its assets.
On a side note, we noticed that the improvement in ROCE appears to be partly fueled by an increase in current liabilities. The current liabilities has increased to 33% of total assets, so the business is now more funded by the likes of its suppliers or short-term creditors. It's worth keeping an eye on this because as the percentage of current liabilities to total assets increases, some aspects of risk also increase.What We Can Learn From MSP Steel & Power's ROCE
In a nutshell, we're pleased to see that MSP Steel & Power has been able to generate higher returns from less capital. And since the stock has fallen 48% over the last five years, there might be an opportunity here. That being the case, research into the company's current valuation metrics and future prospects seems fitting.
One more thing to note, we've identified 2 warning signs with MSP Steel & Power and understanding these should be part of your investment process.
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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This article by Simply Wall St is general in nature. 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.
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About NSEI:MSPL
MSP Steel & Power
Manufactures and sells iron and steel products in India and internationally.
Adequate balance sheet and slightly overvalued.
