Returns On Capital At CMC (TYO:2185) Paint An Interesting Picture

If we want to find a stock that could multiply over the long term, what are the underlying trends we should look for? Firstly, we'd want to identify a growing return on capital employed (ROCE) and then alongside that, an ever-increasing 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. However, after briefly looking over the numbers, we don't think CMC (TYO:2185) has the makings of a multi-bagger going forward, but let's have a look at why that may be.

What is 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. To calculate this metric for CMC, this is the formula:

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

0.10 = JP¥1.7b ÷ (JP¥19b - JP¥2.3b) (Based on the trailing twelve months to December 2020).

Therefore, CMC has an ROCE of 10.0%. On its own, that's a low figure but it's around the 8.4% average generated by the Commercial Services industry.

See our latest analysis for CMC

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 want to delve into the historical earnings, revenue and cash flow of CMC, check out these free graphs here.

What The Trend Of ROCE Can Tell Us

On the surface, the trend of ROCE at CMC doesn't inspire confidence. Around five years ago the returns on capital were 15%, but since then they've fallen to 10.0%. Given the business is employing more capital while revenue has slipped, this is a bit concerning. If this were to continue, you might be looking at a company that is trying to reinvest for growth but is actually losing market share since sales haven't increased.

The Key Takeaway

From the above analysis, we find it rather worrisome that returns on capital and sales for CMC have fallen, meanwhile the business is employing more capital than it was five years ago. Yet despite these poor fundamentals, the stock has gained a huge 225% over the last five years, so investors appear very optimistic. In any case, the current underlying trends don't bode well for long term performance so unless they reverse, we'd start looking elsewhere.

On a separate note, we've found 1 warning sign for CMC you'll probably want to know about.

While CMC isn't earning the highest return, check out this free list of companies that are earning high returns on equity with solid balance sheets.

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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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