Will CMC (TYO:2185) Multiply In Value Going Forward?

To find a multi-bagger stock, what are the underlying trends we should look for in a business? 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. In light of that, when we looked at CMC (TYO:2185) and its ROCE trend, we weren't exactly thrilled.

What is Return On Capital Employed (ROCE)?

For those who don't know, ROCE is a measure of a company's yearly pre-tax profit (its return), relative to the capital employed in the business. The formula for this calculation on CMC is:

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

0.11 = JP¥1.8b ÷ (JP¥20b - JP¥2.6b) (Based on the trailing twelve months to September 2020).

So, CMC has an ROCE of 11%. In absolute terms, that's a satisfactory return, but compared to the Commercial Services industry average of 7.8% it's much better.

View 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'd like to look at how CMC has performed in the past in other metrics, you can view this free graph of past earnings, revenue and cash flow.

So How Is CMC's ROCE Trending?

In terms of CMC's historical ROCE movements, the trend isn't fantastic. Around five years ago the returns on capital were 15%, but since then they've fallen to 11%. And considering revenue has dropped while employing more capital, we'd be cautious. This could mean that the business is losing its competitive advantage or market share, because while more money is being put into ventures, it's actually producing a lower return - "less bang for their buck" per se.

The Bottom Line

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 154% 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.

If you want to continue researching CMC, you might be interested to know about the 1 warning sign that our analysis has discovered.

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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