Elkem (OB:ELK) Is Very Good At Capital Allocation

To find a multi-bagger stock, what are the underlying trends we should look for in a business? Ideally, a business will show two trends; firstly a growing return on capital employed (ROCE) and secondly, an increasing amount of capital employed. Basically this means that a company has profitable initiatives that it can continue to reinvest in, which is a trait of a compounding machine. With that in mind, the ROCE of Elkem (OB:ELK) looks great, so lets see what the trend can tell us.

Return On Capital Employed (ROCE): What Is It?

If you haven't worked with ROCE before, it measures the 'return' (pre-tax profit) a company generates from capital employed in its business. Analysts use this formula to calculate it for Elkem:

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

0.29 = kr12b ÷ (kr53b - kr12b) (Based on the trailing twelve months to December 2022).

So, Elkem has an ROCE of 29%. That's a fantastic return and not only that, it outpaces the average of 12% earned by companies in a similar industry.

See our latest analysis for Elkem

In the above chart we have measured Elkem's prior ROCE against its prior performance, but the future is arguably more important. If you're interested, you can view the analysts predictions in our free report on analyst forecasts for the company.

The Trend Of ROCE

Elkem is displaying some positive trends. The numbers show that in the last five years, the returns generated on capital employed have grown considerably to 29%. Basically the business is earning more per dollar of capital invested and in addition to that, 182% more capital is being employed now too. The increasing returns on a growing amount of capital is common amongst multi-baggers and that's why we're impressed.

One more thing to note, Elkem has decreased current liabilities to 22% of total assets over this period, which effectively reduces the amount of funding from suppliers or short-term creditors. Therefore we can rest assured that the growth in ROCE is a result of the business' fundamental improvements, rather than a cooking class featuring this company's books.

Our Take On Elkem's ROCE

All in all, it's terrific to see that Elkem is reaping the rewards from prior investments and is growing its capital base. And investors seem to expect more of this going forward, since the stock has rewarded shareholders with a 41% return over the last five years. 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.

If you want to know some of the risks facing Elkem we've found 3 warning signs (1 is a bit unpleasant!) that you should be aware of before investing here.

High returns are a key ingredient to strong performance, so check out our free list ofstocks earning high returns on equity with solid balance sheets.

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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.