When we're researching a company, it's sometimes hard to find the warning signs, but there are some financial metrics that can help spot trouble early. Typically, we'll see the trend of both return on capital employed (ROCE) declining and this usually coincides with a decreasing amount of capital employed. This indicates to us that the business is not only shrinking the size of its net assets, but its returns are falling as well. On that note, looking into KGHM Polska Miedz (WSE:KGH), we weren't too upbeat about how things were going.
What is Return On Capital Employed (ROCE)?
Just to clarify if you're unsure, ROCE is a metric for evaluating how much pre-tax income (in percentage terms) a company earns on the capital invested in its business. To calculate this metric for KGHM Polska Miedz, this is the formula:
Return on Capital Employed = Earnings Before Interest and Tax (EBIT) ÷ (Total Assets - Current Liabilities)
0.067 = zł2.3b ÷ (zł42b - zł6.8b) (Based on the trailing twelve months to September 2020).
So, KGHM Polska Miedz has an ROCE of 6.7%. Ultimately, that's a low return and it under-performs the Metals and Mining industry average of 8.6%.
In the above chart we have measured KGHM Polska Miedz's prior ROCE against its prior performance, but the future is arguably more important. If you'd like, you can check out the forecasts from the analysts covering KGHM Polska Miedz here for free.
What Can We Tell From KGHM Polska Miedz's ROCE Trend?
In terms of KGHM Polska Miedz's historical ROCE movements, the trend doesn't inspire confidence. About five years ago, returns on capital were 8.5%, however they're now substantially lower than that as we saw above. And on the capital employed front, the business is utilizing roughly the same amount of capital as it was back then. This combination can be indicative of a mature business that still has areas to deploy capital, but the returns received aren't as high due potentially to new competition or smaller margins. If these trends continue, we wouldn't expect KGHM Polska Miedz to turn into a multi-bagger.
The Bottom Line
In the end, the trend of lower returns on the same amount of capital isn't typically an indication that we're looking at a growth stock. Yet despite these poor fundamentals, the stock has gained a huge 200% 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.
KGHM Polska Miedz does have some risks though, and we've spotted 2 warning signs for KGHM Polska Miedz that you might be interested in.
While KGHM Polska Miedz 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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